Hawkish central bank decisions from the Fed and ECB dents sentiment. US equites and other risk assets experience 24 hours of heavy selling. PMIs for AUS, UK, EU and US round out a pivotal week

By Stuart Talman, XE currency strategist

Risk aversion has punctuated markets as global growth concerns intensify following hawkish policy updates from the Federal Reserve and the European Central Bank.

Five of the G10’s central banks have raised rates over the past 24 hours, the central bank bonanza delivering 50bps hikes from the Fed, ECB, BoE, SNB and a 25bps hike from Norges Bank, Norway’s central bank.

Whilst the 50bps hikes from the Fed, ECB and BoE were widely expected and were a step-down from a 75bps increment at the prior meetings, the Fed and ECB’s decisions were viewed through a hawkish lens given the clear messaging – rates will continue to be raised and held at their peak for a sustained period.

Following Tuesday’s softer-than-expected US CPI report which initially drove US equites and other risk assets higher, including the New Zealand and Australian dollars, we wrote that markets were showing signs of topside exhaustion.

Those signals have been validated, the S&P 500 forming a technically important double top near 4100 – two days of heavy selling taking the gauge down over 5% from Tuesday’s peak.

Having peaked above 65 US cents on Tuesday, the Kiwi’s peak to trough (overnight lows in the 0.6320’s) move is close to 3%.

We also wrote in regards to Tuesday’s signals....

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.

This looks to be the case given the decisive rejection of recent highs which have coincided with important technical developments.

For the S&P 500 the double top reversal pattern and two day pummelling has driven price action back below not only the 200 day moving average but also the 100 day moving average.

This is a major bearish signal and could be the commencement of another rapid leg lower should rapidly deteriorating risk sentiment due to recessionary fears be the prevailing narrative as we commence the new year.

We also wrote on Tuesday that currency pairs often strive to take out a psychologically important round number, but then fail to extend through as the prevailing trend reaches exhaustion.

This looks to be the base with the Kiwi’s brief peek through 65 US cents followed by Thursday’s aggressive U-turn.

Early 2023 direction will be dictated by the incoming data flow - key readings on inflation, jobs, consumer spending and business activity shaping the major central banks’ late-cycle policy paths and market sentiment regarding the outlook for the year ahead.

Let’s recap the state of play for the Fed, ECB and BoE following their respective monetary policy updates over the past 24 hours.

Starting with the Fed, the key points from Wednesday’s decision:

• Fed hikes rates by 50bps to 4.25% to 4.50%
• Dot plots raised: 2023-end projected at 5.1%
• Material upward revisions to inflation

Whilst a downshift to 50bps following four consecutive 50bps hikes was widely expected, both the dot-plots and Fed chair Powell’s presser were viewed as hawkish.

The message is clear from the Fed – there is still much work to be done to reign in levels of inflation that have not been seen in over 40 years.

Whist the peak in inflation may well have occurred, the Fed clearly believes that inflation will be far stickier than what the market currently has priced in. The big question for the market in 1H 2023.....

Will terminal rate pricing remain near 5%, or will persistently high inflation require the Fed to hike closer to 6%?

If the answer leans towards an even higher terminal rate, US equities very likely log fresh cycle lows, dragging the Kiwi and Aussie dollars back down into the mid-0.50’s and low-60’s, respectively.

Shifting to the ECB, the key points from Thursday’s update:

• ECB hikes main policy rate by 50bps to 2.50%
• QT to commence from March 2023
• Flags significant rate increases ahead

Again, a 50bps kike was widely expected following back-to-back 75bps hikes. The hawkish elements of the eurozone’s central bank policy update coming via the accompanying statement and Lagarde’s press conference.

The statement included surprisingly hawkish language, including “interest rates will still have to rise significantly at a steady pace” and “keeping interest rates at restrictive levels will over time reduce inflation”

ECB Chief Lagarde reiterated this message in her presser stating that 50bps hikes would be the MO for a period of time.

Having peaked above 0.61 against the euro on Tuesday, two days of heavy selling which quickened following the ECB decision has driven the Kiwi to within a few pips of 0.5950.

Finally, to the BoE who unlike the Fed and ECB delivered a dovish update. The key points:

• BoE hikes by 50bps to 3.50%
• 2 of 9 officials voted to keep unchanged
• Terminal rate expected close to 4%

Following the BoE’s inaugural 75bps hike in November, the UK central bank has downshifted back to 50bps, flagging a more cautious approach ahead.

With 2 of 9 BoE officials voting to keep rates unchanged (whilst one official voted for a 75bps hike), it’s clear the BoE is becoming more divided regarding the near-term path for rates.....a dovish signal to the market.

The base case is now for a further 50bps of hikes for 1H 2023 to end the cycle at a terminal rate at 4%.

The pound was aggressively sold in response, falling over 2% against the dollar from north of 1.2400 to overnight lows near 1.2150.

The Kiwi is flat against the pound, NZDGBP recovering from 0.5160 to start Friday back near 0.5200. We still favour Kiwi outperformance versus the pound in 1H 2023.

Shifting our focus to the day ahead – its PMI day to end the week, S&P Global’s readings on manufacturing and services activity for the Australian, UK, eurozone and US economies.

Given the clear shift in sentiment driven by Fed and ECB hawkishness and major rejections of important upside technical levels, we favour further downside, albeit the velocity of selling to slow.

Expectations are for the Kiwi to end the week anchored around 63 US cents.

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