By Stuart Talman, XE currency strategist
Markets have slipped into wait-and-see mode ahead of this week’s major event – December US CPI, released 2:30am, Friday.
US equities are a little firmer heading into the New York afternoon but still remain below Monday’s peak following a strong two day upside surge off the back of an encouraging US jobs report last Friday.
The New Zealand dollar has traded with a mild downside bias over the past 24 hours, again encountering intraday resistance near 0.6390 whilst logging overnight lows in the 0.6330’s.
The next key directional move for markets is likely to be driven by the data flow providing evidence as to who (the Fed or the market) is more accurately predicting the path for the Fed funds rate through 2023.
The Fed has made it clear through both its policy decisions and rhetoric – the policy rate will be lifted north of 5% and held their for some time.
The market does not agree.
Current market pricing calls for a terminal rate just shy of 5% - not too far away from where the December dot plots represented the Fed’s median projection.
However, where the Fed and the market more noticeably differ is their respective projections for the second half of 2023.
Market pricing suggests that the Fed will pivot (2022’s most overused word) in 2H, cutting the Fed funds target rate by ~50bps, a policy shift that will likely be driven by the slowdown gaining momentum through the first and second quarters, sending the US economy into recession as we head into the second half of 2023.
The Fed, on the other hand, believes that rates will be held at their peak for longer, buying into the notion that the US economy will avoid recession or at the very worst, encounter a short shallow recession.
This soft landing scenario permits the Fed to keep their foot firmly pressed on the throat of inflation as the Fed engineers the seemingly impossible – tighten at a historically aggressive pace whilst not breaking anything.
Yeah, right.
Remember, the Fed has a terrible forecasting track record.....especially when it comes to inflation, which to be fair, is never easy to predict.
In late 2021 its projection for the year-end fed funds rate for 2022 was around 1%.....the terminal rate was expected to reach 2% in 2024.
2021 was all about “transitory”, 2022 the “pivot.”
What will be 2023’s buzzword?
Another light day for news flow devoid of major event risk has ensured that ranges remain condensed, the largest daily declines for the Kiwi occurring versus the EUR and the AUD, sliding close to half-a-percent.
Back in late September the euro was in a dark place, logging 20+ year lows below 0.96 versus the dollar, sentiment further deteriorating as natural gas prices rocketed to unprecedented levels, seemingly catapulting the eurozone into a full blow energy crises and a nightmarish recession.
The worm has turned for the shared currency.
Natural gas prices have aggressively reversed course due to mild, early-winter weather, the ECB has belatedly delivered its own hawkish pivot and eurozone data-flow has mildly improved through 4Q.
Having topped out just north of 0.61 on 13 December, NZDEUR has established a lower range between 0.5890 and 0.6000 over the past few weeks.
The key near-term upside level to monitor is 0.5996 – the 50% retracement of the August-October downswing. Earlier in the week, NZDEUR touched this level, which also currently aligns with the 200 day moving average, but failed to extend through.
On the downside, were price action to consolidate below 0.5890 to then slide through the 23.6% Fibonacci retracement (located at 0.5839) of the aforementioned downswing, the pair’s 1Q outlook shifts negative.
The ECB next meets on 02 February, expected to deliver another 50bps hike, lifting the despot rate to 3.00%.
Having peaked a couple of pips shy of 0.9550 on 16 December, the Kiwi continues to slide against the Aussie, price action treading water above 0.92 over the past week.
Yesterday’s monthly CPI reading of the Australian economy came in stronger than expected, headline inflation rising to an annualised rate of 7.3%, up from 6.9% the month prior.
The rate sensitive NZDAUD was trading in the 0.9240’s before the CPI release, falling steadily throughout all Wednesday’s session to log early morning lows a few pips below 0.92.
We expect the pair will settle into a range in the coming weeks following 6 months of see-sewing price action.
Retail sales the other key Aussie macroeconomic data point released yesterday, household spending delivering a strong upside surprise for November, logging its strongest pace of gains since January. The Black Friday sales a huge contributor to the result.
To the day ahead – it’s all about the US CPI report for December. The numbers to watch – annualised headline inflation expected to fall from 7.1% to 6.5% whilst core (ex food and energy) is expected to ease from 6.0% to 5.7%
When US CPI was last released on 13 December, the second consecutive downside miss propelled the New Zealand dollar higher from the high 0.63’s to 6 month highs through 65 US cents.
If we do receive a third consecutive downside surprise, expectations are for a smaller sized reaction given we’re deeper into the cycle and peak inflation has now been confirmed.
A soft CPI report likely pushes NZDUSD back into the mid 0.64’s.
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Stuart Talman is Director of Sales at XE. You can contact him here.
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