By Stuart Talman, XE currency strategist
Heading into last week, the disinflation trade was the major talking point for markets following softer-than-expected reads in both consumer and producer prices for the US economy.
The Fed would be done after this week's widely expected 25bps hike.
This would mark the commencement of a cyclical downturn for the US dollar.
Not so fast.
Whilst it was a quiet week for US macroeconomic data flow, the dollar rebounded as its major peers faltered, the New Zealand dollar the week's softest performer amongst the G10, plunging over 3%. The JPY and GBP also struggled, the former pummelled following a Reuters piece (FRI.), reporting the Bank of Japan is likely to refrain from tweaking current policy settings. GBP bears took their cue from weaker than expected CPI data, the first downside miss in five months.
Thursday's weekly jobless claims number was the noted data point, printing at its lowest for 2 months, representing a US labour market that continues to defy Fed tightening.
Whilst its good news for the US economy, businesses and households, ongoing labour market tightness raises the chances of a resurgence in consumer prices, thereby requiring the Fed to keep hiking.
The market has bought into the soft landing/no landing narrative through the first 7 months of the year, evidenced by astounding run in US equity markets.
The S&P500 is now only ~5% away from its all-time record high!
The Nasdaq's year-to-date gains exceed 40%!
The Dow's marginal gain on Friday extended its current winning streak through a 10th day, its best run in over 6 years!
All whilst the Fed has tried to slow the economy with over 500bps of monetary tightening.
Recession has been priced out, good times priced in.
The market is complacent.
Could Jay Powell and his colleagues keep hiking the Fed funds target rate through 6%?
You bet.
Yes, inflation has meaningfully receded from 40+ year peaks, but no, the battle has not been won.
Soaring US equities boosts the wealth effect, in turn fuelling household spending, the largest component of GDP. Regardless of whether Americans own a stock portfolio or not, and so long as they have a job, Americans will spend as higher equities boosts confidence.
This is precisely what the Fed doesn’t want as it places upside pressure on consumer prices, making it a difficult task to return inflation to the 2% target.
This week's FOMC meeting will be crucial in determining the market's mood and the next leg for US equities and other risk assets. Given a quarter point hike is widely expected, the focus will not be on the decision itself, rather the accompanying statement and Chair Powell's presser.
Will Powell aim to quell the stock market's animal spirits by implying the Fed has more to do?
Should he do so, the dollar continues to rebound.
Having peaked a couple of pips through 0.6410 on 14 July, last week delivered 5 days of intraday losses for the Kiwi, ending the week a few pips above 0.6160. Selling momentum quickened into the week's close, indicative of NZD bears in full control.
It’s the fifth occasion over the past 5 months that NZDUSD has swiftly rejected an ascent into the 0.6380 - 0.6420 resistance zone. Poor sentiment regarding China's growth outlook, US economic outperformance and a dovish RBNZ shift, the strong headwinds that ensure NZDUSD cannot make a decisive break through 64 US cents.
Falling below old technical resistance at 0.6220 to once again trade below the 100 and 200 day moving averages suggests further downside beckons for the Kiwi, testing the 0.6050 - 0.6100 support zone.
Following a relatively quiet week, this week really heats up……and that's an understatement!
On the central bank front, the ECB and BoJ join the Fed in holding monetary policy meetings. ECB Chief Lagarde and her GC colleagues are expected to hike the main deposit rate by 25bps to 3.75% and flag that more work is to be done given core inflation remains uncomfortably high. Like the Fed, the outcome will not be the major focus, instead any forward guidance offered.
As mentioned earlier in the update, a Reuters article on Friday reported that the BoJ is not considering a policy tweak this week….
With the 10-year yield moving stably below the 0.5% yield cap, however, many BOJ policymakers see no imminent need to take fresh steps against the side-effects of YCC, the sources said.
They also believe the BOJ can afford to wait until there is more clarity on whether the global economy can avert a hard landing and allow Japanese firms to earn enough profits to keep hiking wages next year, they said.
Attention will be given to the composition of the vote and accompanying statement/comments to evaluate if a YCC tweak occurs at the September or October BoJ meetings.
The Kiwi continues to range trade against the yen, NZDJPY shedding just shy of one-percent for the week to close near 87.50, near the midpoint of the past few weeks 86.50 - 88.50 range.
Whilst it’s a quiet week for local data releases, across the Tasman, 2Q CPI is the headline regional event. Consumer prices for the Australian economy are expected to further fall, the RBA's preferred gauge, the trimmed mean, easing from 6.6% in 1Q to an expected 6.0%.
An upside surprise would likely lock in an RBA hike on 01 August, driving the antipodean cross lower. Falling in four of the past five trading days, NZDAUD has pulled back from 0.9320 to Friday's low at 0.9160 during this period. The key level of near-tern support resides at 0.9050…..a break through here, the pair likely re-tests the June low near 0.9050.
The week kicks off with PMI-day, S&P Global's preliminary readings of manufacturing and services activity for the major economies. The theme continues: manufacturing is clearly in recessionary territory whilst the service sector remains expansionary.
On the earnings front, it’s a big week: Alphabet (Google), Microsoft, Meta and Intel the headline reports. Last week was interesting: Netflix and Tesla beat expectations yet were hammered due to poor guidance…..will this be the overriding theme for 2Q earnings?
US equity markets suggest not…..and therefore susceptible to an earnings induced correction should the big names project softening demand.
Will the Kiwi end its slide this week?
The answer lies with the Fed.
A hawkish statement and FOMC presser would open a path down to 60 US cents whilst a dovish 25bps hike sends the Kiwi back through 63 US cents.
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Stuart Talman is Director of Sales at XE. You can contact him here.
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