By Stuart Talman, XE currency strategist
The fireworks have started!
A softer-than-expected US CPI report lighting up the screens in a sea of green for risk sensitive assets.
US equity markets opened sharply higher, the S&P 500’s gains approaching 3% shortly after the opening bell, whilst the rate sensitive Nasdaq climbed just shy of 4%.
Heading into the New York afternoon, the exuberance has evaporated, the S&P 500 up around half-a-percent, the Dow slipping into negative territory whilst the Nasdaq outperforms, up close to 1%.
The New Zealand dollar rocketed higher, trading through 65 US cents for the first time since early June. Trading around 64 US cents just prior to the CPI release, the Kiwi has logged overnight highs a few pips above 0.6510.
Following on from the cooler US CPI report for October (released 10 NOV.), many a market talking head had declared that inflation had peaked, the Fed could now start to slow the pace of rate hikes and that maybe, just maybe, a soft landing may occur for the US economy.
At that point it was only the second month over the preceding 7 months that core (ex food and energy) inflation had printed softer than consensus estimates.
Now we have two consecutive months of a favourable downside inflation miss, annualised core inflation falling from 6.3% to 6.0% (versus expectations of 6.1%).
Core inflation peaked at 6.6% during September.
The sharp decline in energy prices over the past couple of months has driven headline inflation sharply lower from 7.7% to 7.1% (versus expected 7.3%). Having peaked at 9.1% in June, it’s the lowest reading for headline inflation in 12 months.
So, what does this mean for the Fed, this week’s FOMC meeting and further out - the path and end-point of the Fed funds rate?
It probably doesn’t change the Fed’s playbook in the short term – a 50bps hike to a target rate of 4.25%-4.50% the likely outcome of tomorrow’s interest rate decision.
Regarding the terminal rate, the CPI result adds weight to the case for a terminal rate remaining around the 5% mark whilst perhaps shortening the period in which the Fed holds the policy rate at its peak.
Terminal rate pricing, as measured by the Fed funds futures curve, eased further, falling below 4.85% having crept above 5% early last month.
This implies that the Fed will add an additional 50bps of hikes early next year, likely a mix of 25bps at the January meeting and a final 25bps at the March meeting.
The market will be engrossed with the latest edition of the FOMC dot-plots accompanying tomorrow’s monetary policy update and Powell’s press conference.
Will the dot-plots align with market pricing, or will we receive a more hawkish than expected update with a series of dot-plots from FOMC officials projecting a policy rate above 5% during 2023?
The answer to this question will dictate whether US equities and other risk assets extend higher or the impressive rally that commenced in mid-October is quashed.
The other tier 1 data event for Tuesday was the UK labour market report which again displayed resiliency via a larger than expected jobs growth component and higher weekly (ex-bonus) earnings. This is the strongest earnings growth rate outside of the pandemic period – not an ideal development for the BoE as the inflation fight continues.
The BoE meets this week, widely expected to shift down to a 50bps hike having hiked by 75bps for the first time back in November. Lifting the policy rate to an expected 3.50%, market pricing currently calling for a terminal rate near 4% early next year.
Against the pound, the Kiwi has been grinding higher over the past two months, ascending back into a 0.5100 to 0.5250 range that constrained price action from April through August.
The pair spiked to a 4 year high near 0.5480 in September when the UK bond market was on the brink of imploding to then plummet below 0.4950 as the Truss-Kwarteng government was ousted and fiscal responsibility restored.
Price action has been concentrated in the low 0.52’s through the first half of December. We look for NZDGBP to reclaim territory above 0.53 early in the new year as the BoE nears the end of its tightening cycle and economic activity declines.
More tier 1 UK data is released this evening – November UK CPI data expected to report headline inflation at 10.9% having printed at 11.1% for October.
Other key events for Wednesday include RBA Governor Lowe speaking at the AusPayNet Annual Summit and Japan’s Tankan (manufacturing) survey.
Thursday is when the action steps up again, headlined by the FOMC interest rate decision, dot plots and statement. Powell’s’ presser to follow 30 minutes later at 8:30am.
Local 3Q GDP, Aussie jobs numbers and retail sales for China ensures there is no let-off during the Asian session, whilst BoE and ECB rate decisions in the evening cap off what should be a frenetic Thursday.
Will the Kiwi extend higher through 65 US cents?
As we complete and release this morning’s update, NZDUSD has pared gains, retreating back to 0.6460. US equities have given back most of their large gains.
It’s a tentative sign of topside exhaustion.
Often in the currency markets, you’ll see a currency pair strive to touch a psychologically important round number – in this case 65 US cents.....and the fail to maintain the directional bias.
It would not surprise if the Fed delivers a hawkish 50bps hike via a higher than expected set of dot plots and Powell talking tough during his press conference.
As we work our way through this pivotal week and into the festive season, we’ll likely enter a period of more subdued trade....Tuesday’s price action may have formed a short to medium term high.
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Stuart Talman is Director of Sales at XE. You can contact him here.
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