By Stuart Talman, XE currency strategist
Inflation in the US has run hotter than expected through December tempering the market's expectations for the Federal Reserve to commence cutting the target rate as soon as March.
Following the release of the CPI data, risk-off flows have punctuated US trade, the three major equity indices pulling back from recent swing highs as treasury yields at the long end of the curve move modestly higher, the yield on the benchmark ten-year note ascending back through 4.00%, continuing to consolidate its late December rebound from around 3.80%.
The US dollar is mixed against all its major peers, net changes amongst the G10 have been relatively contained, representative of a market that was anticipating a modest CPI beat.
The New Zealand dollar is a middling performer on the G10 leaderboard, improving through the second half of the US session to trade flat for the day. Prior to the CPI release, NZDUSD ranged between 0.6240 and 0.6260 through the Asian afternoon and into the New York morning. Immediately following the CPI print, the Kiwi plunged back below 62 US cents to mark intraday lows around 0.6195.
Choppy, directionless trade has ensued through the first half of US trade, the Kiwi endeavouring to re-establish a foothold above 0.6200.
Core inflation through December climbed by +0.3% bringing the annualised rate to 3.9% (vs 3.8%, expected) whilst headline printed at 0.3% MoM, yielding an annualised rate at 3.4% (vs 3.2%) expected.
Whilst the inflation doves will be encouraged by core inflation falling below 4% for the first time since May 2021, the hawks will sustain their messaging: the disinflation process is taking longer than expected, price pressures remain stubbornly high.
Both the CPI data and last Friday's stronger-than-expected employment report reinforces the view the market had gotten overzealous by pricing half-a-dozen 25bps cuts for the year ahead with the first to be delivered in March.
Its unlikely inflation will be returned to the Fed's 2% target through 2024, and whilst there are signs the labour market is softening, it still remains tight by historical standards.
These are not conditions that will prompt Jerome Powell and his FOMC colleagues to initiate a monetary easing cycle.
Should the macroeconomic data flow continue to represent solid economic growth (the Atlanta Fed's GDPNow tracker currently estimates 2.2%) whilst the unemployment rate remains around 4% (currently steady at 3.7%), the Fed likely won't be cutting rates until deep into the second half of the year.
In this scenario the dollar would defy consensus forecasts and at the very least hold its ground with the potential to move higher.
The alternative scenario for the dollar - a lower path throughout 2024 as the world's largest economy notably cools under the weight of higher borrowing costs leading to significant lay-offs, lifting the jobless rate into the 4.5% - 5% region.
Note, the Fed retained its projected unemployment rate of 4.1% via the release of its latest summary of economic projections at the 13 December FOMC meeting, implying the US economy would achieve a soft landing despite unleashing the most aggressive monetary tightening campaign in over 40 years.
Both history and economic theory would suggest this is unlikely - pain must be felt in the labour market to return inflation to targeted levels.
That being said, the post-pandemic global economy, propped up by record levels of fiscal stimulus, has not responded as expected…..perhaps this time will be different and Jerome Powell threads the needle to defy history.
Turning our attention to the final trading day of the week, the local session delivers CPI, PPI, and trade balance data for China whilst offshore the focus will be on the Producer Price Index for the US economy.
Fourth quarter earnings season kicks off in the US with the big banks reporting.
Early afternoon trade in New York has seen risk sensitive assets pare most of the CPI-induced losses - the Kiwi improving back through 0.6230 with a couple of hours of the US session to trade.
The NZD bears appear unwilling to drive price action much below 62 US cents, despite the stronger CPI data. We suspect NZDUSD continues to consolidate between 62 and 63 US cents as it awaits the next major directional catalyst.
Stuart Talman is Director of Sales at XE. You can contact him here.
We welcome your comments below. If you are not already registered, please register to comment.
Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current comment policy is here.