By Stuart Talman, XE currency strategist
US equity markets added to a painful week of losses, the three major indices falling close to 1% as stronger than expected producer prices reminded of the Fed’s higher for longer mantra.
Falling close to 3.50% for the week, it was the largest weekly decline for the S&P 500 since late September – the week when UK bond markets were on the precipice and the pound got smoked.
Despite softer US stocks, the new Zealand dollar again sat atop the G10 leader board, climbing for a third day to eek out a marginal gain for the week.
Closing the week above 64 US cents, the Kiwi maintains its upside bias, but like many risk-sensitive assets, further topside has looked a little shaky over the past week or so.
The Producer Price Index (PPI) measures inflation at the business level and along with CPI and PCE is a key gauge the Fed will use in determining the path of monetary policy.
PPI surprised to the upside.
Given that inflation in the US looks to have peaked a few months back, the focus has now shifted to how “sticky” or persistent prices will be. The Fed and the US economy’s preferred scenario – inflation falls steadily back to the 2% target over the next few years.
However history tells us that when inflation has been north of 8%, it takes far longer than a few years to decline back to targeted levels.
Whilst the PPI data showed a cooling of price pressures on a year-on-year basis (core falling from 6.7% to 6.2%), the decline was less than the consensus forecast of 6.0%. Prior PPI results were also revised higher.....not the Fed’s desired outcome.
The upside PPI beat immediately propelled the USD higher, the Kiwi falling from the low 0.64’s to mark Friday’s low at 0.6360.
However the dollar bulls were unable to maintain control through the back-end of the week’s final session as a stronger than expected preliminary Uni of Michigan Consumer sentiment survey (UoM) reversed the PPI-induced reaction.
The UoM survey has been getting a lot of air time this year, predominantly due to the forward-looking inflation expectations sub-gauges that report on what level consumers expect inflation to be at in 1 and 5 years’ time.
Fed Chair Powell referred to the UoM survey and rising inflation expectations back in June, citing this is a factor in the FOMC’s decision to implement the first of four consecutive 75bps hikes.
Encouragingly, Friday’s UoM reported that 1year inflation expectations continue to moderate, falling to the lowest level since September 2021.
This was the catalyst that reversed the dollar’s gains, lifting the Kiwi to within a few pips of 0.6430 before ending the week closer to 64 US cents.
It was a week that started with heavy selling, due in part to a stronger-than-expected ISM Services PMI release and an article from the Fed whisperer – WSJ’s Nick Timiraos, cautioning that the Fed will continue to raise rates higher than current market expectations.
Following last Monday’s rout, which pushed the Kiwi back down near 63 US cents, the remainder of the week delivered a steady ascent, the main driver being positive developments regarding a relaxation of China’s Covid protocols.
The week also delivered a second consecutive 25bps hike from the RBA, lifting the cash rate across the Tasman to 3.10%.
The RBA signalled that additional rate rises were likely, dependant on incoming data – a mildly hawkish policy update given some had expected the RBA may signal a pause in its statement.
For the week, the Kiwi was pretty much flat against the Aussie, closing near 0.9430 having climbed through 0.9490 at the week’s highs.
The antipodean cross looks extremely stretched at these levels, having extended beyond what the fundamentals should dictate.
Yes, the RBNZ is relatively hawkish compared to the RBA, however this has already been baked into NZDAUD levels following the RBNZ’s historic 75bps hike to 4.25% on 23 November.
The Kiwi has added close to another 2.5% against the Aussie over the past fortnight.
Australia’s significantly superior terms-of-trade and lower probability of recession, likely to deliver lower NZDAUD levels through 2023.
Against other major peers, the Kiwi continues to track higher, logging small weekly gains versus both the pound and the euro, attempting to mount upside breakouts beyond 0.5230 (NZDGBP) and 0.6090 (NZDEUR).
Interest rate decisions from the BoE and ECB this week will likely determine key directional moves as we round out the year.
The Kiwi’s largest weekly gain was achieved against the Japanese yen, climbing close to 3%, consolidating above a key 87.00 – 87.35 resistance zone. Provided risk sentiment remains buoyant this week, NZDJPY looks likely to log fresh year-to-date highs above 88.00.
To the week ahead – it is a grand finale of sorts.
It’s a huge week for central bank decisions – the Fed the main event in addition to the aforementioned BoE and ECB policy updates......all three expected to hike by 50bps.
The FOMC focus will be on the dot plots and Powell’s presser. In September, the dot plots were raised – the median projected terminal Fed funds rate at 4.6%. This is expected again be raised – closer to 5%. Attention will also be on the expected path for 2023 and 2024.
The market is still at odds with the Fed, pricing in rate cuts for 2H 2023.
A hawkish raise from the Fed in addition to hawkish language at Powell’s presser, potentially flagging a terminal Fed funds rate north of 5% likely to weigh on US equities and other risk sensitive assets including the Australian and New Zealand dollars.
Before we receive the FOMC decision and dot plots, arguably the week’s biggest event drops – US CPI for November.
October’s CPI rose less than expected catapulting risk assets higher through November and early December. Expectations are for a core reading of 6.4%, higher than the prior month’s 6.3%. September’s reading is the current peak of this cycle, printing at 6.6%.
Some argue that CPI rather than the FOMC meeting is the week’s pivotal event.
Another softer than expected inflation report likely opening a path to higher ranges for stocks, commodities and pro-cyclical currencies.
The week’s major local event is 3Q GDP, Thursday – the economy expected to grow at an annualised rate of 1.9%, up from 0.4% for 2Q.
Aussie jobs numbers and retail sales for China and the US also events of note for what might prove to be a monumental week.
In simple terms – a soft US CPI and moderately hawkish Fed likely drives the Kiwi through 65 US cents.....conversely if Powell chooses to send an aggressive message in the wake of a stronger than expected US CPI, the Kiwi plummets back through 63 US cents and lower.
Or, this time next week we could be trading near current levels should we receive no surprises......this seems the least likely outcome.
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Stuart Talman is Director of Sales at XE. You can contact him here.
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