St. Louis Fed President Bullard challenges market assumptions that tamer rate hikes are what can be tolerated, argues for sharper and earlier hikes. He is a hawkish FOMC voting member

By Stuart Talman, XE currency strategist

Selling pressure continued throughout Thursday’s sessions as hawkish Fed officials drove the dollar and US yields higher, whilst UK Chancellor Hunt delivered his widely expected austere Autumn fiscal update.

The New Zealand dollar’s impressive rebound from cycle lows near 55 US cents, logged on 13 October, has slowed this week as risk assets look for their next directional cues.

The aggressive 5 week rally has propelled the NZD over 12% higher, Tuesday’s highs lifting NZDUSD through 62 US cents for the fist time since late August.

Softer-then-expected US inflation, expectations for the Fed to slow the hiking cycle, Fed funds rate terminal pricing slipping back below 5% and positive news flow regarding China relaxing its covid-zero policy whilst supporting its beleaguered property sector, have been the catalysts for the impressive relief rally.

Year-end seasonals also supporting risk positive flows.

However, markets are non-linear, never carving out a straight line path – it appears this week that a pause and re-assessment is required before a potential resumption of the upside leg.

The Kiwi had mostly been ranging between 0.6120 and 0.6180 over the past 48 hours, a second consecutive day of declines pushing the currency pair below 0.6120 support, marking overnight lows a few pips above 0.6060.

We may well have commenced a period of consolidation this week as markets await the final release of key macroeconomic data that will influence the Fed’s policy path for early 2023.

These key upcoming events include US employment data on 02 December and US CPI on 13 December, the latter released the day before the final FOMC meeting for 2022 – Jerome Powell and his voting colleagues expected to downshift to a 50bps hike to lift the year-end Fed funds target rate to a 4.25%-4.50% range.

Market expectations as measured by the Fed funds futures curve currently prices the terminal rate peaking near 5% during May.

A wave of Fed speakers have delivered a unified message in the wake of the fourth consecutive 75bps hike, delivered on 02 November – the inflation battle has not been won, there is still much work ahead, rates will be held higher for longer.

The hawk of hawks, St. Louis Fed President James Bullard spoke before the open of Thursday’s US session, commenting that to date, the Fed’s hikes have only had a limited effect on inflation and that a 5% Fed funds rate is the minimum level for restrictive policy.

He went to say that rates may need to rise further into a 5% - 7% range.

The number one near-term factor that is driving price action across risk assets is the 5% line in the sand for the Fed’s tightening cycle end-point.

Should Bullard prove correct leading to rates markets re-pricing a policy rate closer to 6% or even higher, US equites will be crunched, dragging the Kiwi and Aussie dollars back down towards cycle lows.....perhaps even lower.

The data flow to end the year and through 1Q 2023 critical in determining when the Fed stops tightening. US jobs numbers remain robust, whilst this week’s retail sales data reported household spending at its strongest level in 8 months.

Undesirable outcomes when attempting to suppress demand in order to rein in multi-decade high inflation.

Turning our attention across the Atlantic, the UK government’s budget announcement was the major event for markets, Thursday.

As expected Jeremy Hunt, the UK chancellor announced a string of tax increases and tighter public spending to plug a £55 billion hole in the public finances.

Just over half will be recovered via higher taxes for high income earners as income tax allowances are frozen and the highest tax bracket is lowered.

Energy companies will also pay higher taxes, a levy on their profits rising to 35% from 25% from January 1 through to 2028.

Hunt is also scaling back the existing energy price cap, UK households to pay a maximum energy bill of £3,000, up from the previously promised £2,500.

The crucial outcome for the fiscal package was to present a plan which will deliver debt stabilisation as a percentage of GDP in the medium term – the Office for Budget Responsibility (OBR) confirming this will be the case by the fiscal year 2027-28.

Controversially and foolishly, Truss and Kwarteng decided to circumvent the OBR when they made their catastrophic mini-budget announcement in late September.

Given much of Hunt’s budget had been widely expected, market reaction was muted. Sterling fell against the dollar whilst the yield on 10 year gilts rose modestly to trade through 3.20%. A little over a month ago, the 10 year yield was peaking through 4.60%.

The UK is heading for a recession, if not already in one, confirmed by the OBR’s projections – UK GDP to contract by 1.4% next year.

As for the BoE, Hunt’s budget unlikely to impact the near term path for the policy rate – the BoE also expected to downshift to 50bps in December with a 25bps or 50bps hike to follow in February.

The BoE’s terminal rate expected to peak around 4%.

The Kiwi continues to range between the 38.2% and 50% Fib retracements of the late September to mid-October downswing, located at 0.5135 and 0.5201 respectively.

The pair looked to be setting-up for a break above 0.52 earlier in the week, unable to do so against the backdrop of easing positive risk sentiment.

We favour a topside breakout though December with a higher range forming above 0.52.

In other news, yesterday, Aussie employment numbers came in stronger-than-expected – jobs growth accelerating and the unemployment rate falling back to a 50 year low at 3.4%.

The immediate reaction was a lower NZDAUD cross, sliding to within a few pips of 0.91. From here it’s been one-way traffic, the cross climbing over half-a-percent, through 0.9150.

Its hard to get a read on the antipodean cross – will the NZD continue its recent outperformance versus the Aussie and break through 0.92 or has the rebound ceased?

We likely get the answer at next Wednesday’s  RBNZ interest rate decision where both 75bps and 50bps are in play.

It’s a very quiet Friday to end the week, devoid of any tier 1 data releases. ECB president Lagarde headlines the final procession of central bank speakers for the week.

The Kiwi has recovered some ground as he head into the New York afternoon, rebounding from below 0.6070 to 0.6130 with a couple of hours of US trade remaining.

Expectations are for tight ranges through Friday’s sessions, the Kiwi to end the week near 61 US cents.

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