Risk sentiment dented as Gaza ceasefire reports prove false. Nasdaq & S&P500 log worst October in 5 years. Bond yields ease on safe haven flows. A mammoth week ahead: BoJ may upstage the US Fed

By Stuart Talman, XE currency strategist

As hopes for a reported ceasefire agreement evaporated throughout US trade, risk sensitive assets faded into the week's close, Israel stepping up its retaliatory bombardment of Gaza, announcing that preparations had been made to initiate new ground incursions into the Gaza strip.

Crude oil climbed just shy of 2%, bouncing from US$82/barrel to end the week above $85, US treasury yields fell as safe haven flows bid up bond prices whilst the S&P500 fell for a third consecutive day, delivering a week-on-week loss of over 2.5%. The Nasdaq logged a comparable weekly loss, but did end Friday's session in the green, outperforming on the back of strong earnings reports from Amazon and semiconductor manufacturer Intel.

Through local trade, much of the New Zealand dollar's price action was contained between 0.5810 and 0.5830, consolidative trade ensuing following Thursday's recovery from a new year-to-date low a few pips above 0.5770.

As ceasefire reports hit the newswires in early London afternoon trade, NZDUSD was bid through 0.5840, on track to close the week in positive territory.

However, the reports were invalidated as the most intense shelling of Gaza induced counter attacks from Hamas, darkening the market's mood as the US session commenced. The Kiwi shed around 40pips into the close, ending the week around a third-of-a-percent lower, a few pips above 58 US cents.

Geopolitical concerns, US economic exceptionalism, elevated US bond yields - major influences that continue to generate strong headwinds for the New Zealand dollar and other risk sensitive assets.

Have we reached peak pessimism, or is there more downside to come?

Amidst deteriorating risk sentiment, the contrarians view the gloom through positive lens, the worst October in five years for the Nasdaq and S&P500 presenting a buying opportunity ahead of the seasonally supportive end of year period for stocks.

Twelve months ago, marking its 2022 year-to-date low in mid-October, the S&P500 climbed over 5% through November as risk sentiment improved from the depths of maximum negativity following an unprecedented four consecutive 75bps Fed hikes.

Basing a couple of pips above 0.5510 in October, the New Zealand dollar ripped higher in the 8 weeks that followed, climbing over 18% to trade through 65 US cents in December as the dollar index topped out, pulling back from ~20-year highs.

The point of this retrospective: to illustrate that at its darkest hour, the market can turn on a dime as investors subscribe to the view that peak negativity is now in the rear view.

Shifting our focus back to the present, this begs the question: have we reached peak negativity?

Probably not.

In the short term, an escalation of the Israel-Hamas conflict that involves the US and Iran stepping up their involvement, presents significant downside vulnerabilities for risk sensitive currencies such as the New Zealand and Australian dollars.

Should crude oil extend beyond US$100 as a Middle East war rages, sentiment will further deteriorate via concerns that a second wave of inflation will require the Fed and other central banks to initiate additional monetary tightening.

Higher energy prices heading into the Northern hemisphere winter could induce the re-emergence of an energy crises that was thankfully averted 12 months ago due to unseasonably warm weather. Should a colder winter playout, significantly higher energy prices would tip the global economy into a deep and protracted global recession……a scenario that the market, at present, heavily discounts.

Via this scenario, the NZDUSD downswing that commenced in early October extends further, setting up a likely re-test of the October 2022 low and sub-55 US cent levels.

Shifting our focus back to the present, technicals suggest the Kiwi will be probing sub-0.5800 levels to start what presents as a colossal week.

Typically, an FOMC meeting would be regarded as the headline event for the week, however the Bak of Japan may steal the limelight given expectations are high that this week’s meeting will call an end to the BoJ’s yield curve control (YCC) policy. Abandoning YCC then opens a path for the BoJ to commence normalisation, lifting the policy rate back into positive territory for the first time since 2016.

Along with the Fed and BoJ, the Bank of England is also meeting this week and like the Fed is expected to maintain current policy settings following last meeting’s pause.

Appl headlines a busy week of 3Q earnings whilst a stacked economic calendar (below) presents a torrent of tier 1 data releases. Locally, Wednesday’s employment report is the main act whist regionally, PMIs for China, and retail sales a trade data across the Tasman present as market movers.

Offshore, some of the potential volatility inducing events include eurozone CPI and the latest read on the US labour market via ADP Employment change, and later in the week, nonfarm payrolls. As if the week want full enough, ISM Manufacturing and Services PMIs are also released.

Should this week continue the trend of strong US macroeconomic data, expect the dollar to continue to outperform, NZDUSD falling further below 58 US cents to mark fresh year-to-date lows in the mid to low 0.57’s.

Alternatively, if we see softening US jobs growth and activity levels via the ISM PMIs, an overbought, stretched US dollar will get crunched……NZD ripping back up through 59 US cents.

We favour the strong dollar path.

Stuart Talman is Director of Sales at XE. You can contact him here.