By Stuart Talman, XE currency strategist
Positive risk sentiment continues to underpin trading conditions, an in-line US CPI report maintaining the market’s brighter mood, propelling risk assets higher from late last week.
Key macroeconomic data for late 2022 and early January has evolved the narrative that inflation has peaked and is moderating, the US economy is experiencing an orderly slowdown, the Fed has entered the final stages of the tightening cycle and maybe, just maybe a harsh recession will be sidestepped.
US CPI for December met expectations – the headline rate printing at -0.1%MoM/6.5%YoY whilst core (ex food & energy) delivered a 0.3%MoM/5.7%YoY outcome. Headline inflation peaked at an annualised 9.1% in June, core at 6.6% in September.
It’s an encouraging result for the Fed and the market, but, by no means is it time to declare that decades high inflation has been conquered.
To return inflation to the Fed’s 2% target, the month-on-month reading must average 0.17% over a 12 month period.
Friday’s weaker than expected wages growth data point and this CPI report has firmed odds for the Fed to again step-down to a smaller hike, the market now pricing in a greater than 90% chance (as measured by the CME FedWatch tool) the Fed funds target rate is lifted 25bps to 4.50%-4.75%.
Should measures of US economic activity continue to track lower through 1Q, the Fed may choose to pause following 25bps hikes at both the 01 February and 22 March FOMC meetings.
This would yield a terminal rate at 4.75%-5.00%, slightly below the Fed’s projection represented in the December dot-plots.
Heading into 2Q, the focus for the market would then be to what extent the data flow and company earnings deteriorates and the developing contours of an expected recession commencing in late 2023/early 2024.
A rapid decline in economic activity – the Fed may cut rates in 2H.....a more orderly and moderate decline, rates are held higher for longer.
Despite the CPI report not delivering a deviation from the consensus outcome, markets have swung around violently immediately following the release at 2:30 this morning. Following two significant downside misses for US CPI in October and November, underpinning 4Q’s risk rally, the market was seemingly braced for a third consecutive below consensus report.
US equities and other risk assets, including the New Zealand and Australian dollars lurched lower as the CPI numbers hit the screen, S&P 500 futures down close to 1%.
Range trading between 0.6340 and 0.6380 throughout Thursday local and European sessions, the Kiwi plunged near 63 US cents to then spike up just shy of 0.6420 before once again spiralling down to within a few pips of 0.6320.
The price action was akin to watching two tennis maestros duking it out on the baseline.
Heading into the New York afternoon, the frenetic price action has calmed, the three major US equity indices settling into positive territory whilst the Kiwi peeks back through 64 US cents, a level that has formed consistent resistance throughout this week.
The net effect – risk assets have maintained the levels that were established following the two-day rally ignited by Friday’s US employment numbers.
The upside bias remains intact.
The US dollar aside, the Kiwi is softer against its other major peers its largest decline occurring against the Japanese yen down close to 2%. Following on from the BoJ’s policy tweak on 20 December, the yen has been the strongest performer amongst the G10 – the move to widen the cap on its yield curve control policy interpreted as the commencement of a new era of tighter monetary policy.
At Monday’s highs NZDJP was trading near 84.70.....Thursday’s lows logged just above 82.50.
The yen is likely to remain in favour – expectations are for NZDJPY to further extend lower, falling to 80.00 over the coming weeks.
The Kiwi also continues its slide against the Aussie, falling through 0.92 for the first time since late November, marking early morning lows a few pips below 0.9170.
The midpoint of the aggressive late September to early December rebound is located at 0.9127 – a likely target for the pair in the days ahead. We look for the antipodean cross to settle into more range bound price action, departing from the uncharacteristically large short/medium term swings that have dominated the pair over the past few months.
Turning our focus to the day ahead, China trade data, monthly GDP for the UK economy and the preliminary reading of the Uni of Michigan consumer sentiment survey are the data points of note......but not likely to significantly influence price action.
The S&P 500 trading up through 4000 and its 200 day moving average; the New Zealand dollar ascending back above 64 US cents; the Australian dollar about to challenge 70 US cents; WTI crude attempting to re-establish a foothold above US$80/barrel......examples of a multitude of risk-sensitive assets clearing important technical resistance levels as bullish sentiment permeates the market.
Expect further upside until the next monkey wrench is hurled via Jerome Powell, China or the data-flow.
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Stuart Talman is Director of Sales at XE. You can contact him here.
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