NZD pulls back in subdued price action, but action intensifies from this evening. The tone and narratives for early 2023 will likely be determined this week

By Stuart Talman, XE currency strategist

It’s been a quiet start to an expected pivotal week, markets awaiting this evening’s US CPI report – the first of multiple key events for the week that may set the tone for markets in early 2023.

Starting the new week in the 0.6390’s, the New Zealand dollar has commenced the week pulling back from recent highs, but still remains firmly entrenched in the prevailing range.

Price action from the 13 October low onwards has revered off cycle lows, forming an aggressive uptrend, propelling the Kiwi to a four month high a few pips above 0.6440, logged on 05 December.

The two catalysts for NZD’s near 17% recovery during this period – evidence that inflation in the US has peaked and China’s pivot to more relaxed Covid protocols, paving the way for a full re-opening in 1H 2023.

Pushing back up through 64 US cents heading into the European afternoon, the Kiwi once again tested a key 0.6420/40 resistance zone that has formed over the past week but was not prepared to extend higher, retreating back through 0.6370 as US yields and the dollar firmed.

US equities, the Kiwi and other risk sensitive assets have been in a holding pattern over the past few trading days, poised for a directional breakout should US CPI deviate from the consensus – an annualised core inflation rate of 6.4%, headline at 7.7%.

Core inflation peaked at 6.6% in September, the 13 October data point coinciding with significant lows for US equities and the New Zealand and Australian dollars.

October’s core reading (released 10 November) surprised to the downside, retreating to 6.3% (versus 6.5%, expected), giving weight to the argument 40+ year high inflation was starting to moderate.

10 November was a huge day for risk sensitive assets, the Nasdaq gaining over 6%, the S&P 500 close to 5%, the Kiwi gaining close to 2%.

Another downside miss would likely deliver another large upside surge, albeit probably not as pronounced as November’s CPI induced rally.

Further evidence that inflation is tracking lower justifies the Fed’s recent signalling to slow the pace of rate hikes – market pricing indicating an over 70% probability that Wednesday’s (THURS. morning, NZDT) FOMC meeting delivers a 50bps hike versus a fifth consecutive 75bps hike.

In addition, it keeps expectations of the terminal rate anchored around 5%, whilst the questions remains – when will the Fed pivot to commence cutting rates?

Current Fed funds futures pricing suggests this will be the second half of 2023 – circa 30bps of cuts priced in.

US equities and other risk sensitive assets have rallied at various times this year on expectations for a Fed pivot, the view being that easier monetary policy will once again propel US stocks and closely correlated currencies, including the Australian and New Zealand dollars, higher.

However, if current market pricing is correct – the Fed does pivot to rate cuts in the second half of next year, this likely spells bad news for the US equity market and by extension NZD and AUD.

Why?

Well, the Fed would be cutting in response to a rapidly deteriorating US economy, entrenched in a deep and prolonged recession.

That’s a risk negative environment in which risk assets are crunched, NZD levels somewhere in the 0.50’s.

We’ll get a clear indication of where the Fed projects that path for rates through 2023 and beyond at this week’s FOMC meeting – the dot plots will be more influential for the market’s reaction function and pricing rather than the rate hike itself.

Its been a remarkable 12 months by a number of different measures, the FOMC dot plots included.

In December last year the median dot plot for the 2022 year-end Fed funds rate was 0.90%. Further out, the dot plots projected 1.6% by the end of 2023 and 2.1% by year-end, 2024.

Thursday morning’s base case of a 50bps hike takes the Fed funds target rate to 4.25% - 4.50%.

When the dot plots were last released in September, the Fed was projecting 4.6% for 2023.

Should we receive a hot CPI print tonight market pricing shifts to a sur-5% environment.....significant tops expected for risk assets.

In addition to this evening US CPI the economic calendar delivers UK jobs numbers and the ZEW Survey (eurozone economic sentiment).

Locally we receive the REINZ house price index report, likely to show further softening for house prices across the nation.

Headlines out of China will also be monitored as the Chinese healthcare system comes under increasing strain due to the more relaxed lockdown requirements.

This time tomorrow morning, we could be observing a New Zealand dollar a significant distance away from current levels, contingent on either an upside od downside US CPI miss.

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