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Market response to July RBA rate decision - Westpac

Research Team at Westpac, suggests that with the backdrop of ongoing Brexit risks, a likely unchanged Fed for the rest of the year and domestic political considerations, FX markets went into today's meeting with the view that we could see the RBA giving a slightly clearer easing bias.Key Quotes“It was not obvious in the first read, hence the pop higher in the A$ to 0.7545 on the release. However, the last paragraph suggests the RBA will be keenly awaiting Q2 CPI (“further information”) to help it address its inflation forecast (“refine its assessment of the outlook for growth and inflation”) and cut if required (“make any adjustment to the stance of policy that may be appropriate”).On the A$, the RBA again stuck to the ‘complicating’ view. This is consistent with the recent shift from ‘adjusting’ language (A$ between 0.70 and 0.74) to complicating (A$ between 0.74 and 0.76).While today’s statement suggests a mild/ CPI dependent easing bias, it has been enough to cap the A$ around 0.7550, and it looks like this should continue. There is much to worry about in the UK/ Europe; it’s hard to see when the Fed will be able to raise rates again and domestic political gridlock cannot help much either. That should be enough to cap the A$ around the 0.7550/ 0.7600 level.AUD where to from here?The near term outlook will be driven by domestic political developments, the Q2 CPI outcome and the RBA's response in August. We tend to see the A$ as expensive above 0.7550/ 0.76, however with global demand for AAA rated yield super strong at the moment, it's hard to see what will push the A$ sharply lower. Thus, we expect the A$ to spend some time in the current 0.73/0.76 range.Bond Market PerspectiveOutright: Any disappointment that the RBA did not absolutely confirm an August rate cut was quickly forgotten as Australian bonds initially traded lower before retracing the losses and pushing higher than they were prior to the Statement. With 3yr bond yields almost a full 25bp through the current cash level, we suspect they tend to move sideways within the range ahead of the Q2 CPI. That is, they are likely to remain around the 1.5% level for now. 10yr bond yields, on the other hand, are looking increasingly sustainable below the 2% level. We certainly think it is too early to fade the push below 2% just yet. The postRBA price action tells me that yield enhancement trades will remain the dominant driver of price action.Curve: The long end has been outperforming and pushing the curve rapidly flatter in recent days. The 3/10yr futures spread is around 910bp flatter than it was a week ago. The question is how much flatter it can go? In our experience the curve tends to have rapid, sharp repricings before consolidating within approximately a 510bp range. We expect similar price action to prevail near term (so a 4250bp range). However, with 3yr yields pushing up against valuation constraints at current levels, the long end is the dominant driver of the curve and there is nothing in either global or domestic environment that is particularly bearish at present.Cross market: We expect the AUUS 10yr Bond spread to trade a 4555bp range for now. We prefer to have narrowers on at the top of the range and be square at the bottom. The obvious driver of divergent Fed and RBA policies is not as dominant as it once was, but the lower US 10yr yields go, the better the pickup into AU bonds will look in a relative sense.”

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