By Stuart Talman, XE currency strategist
Conventional market wisdom heading into 2023 was centred around the view that the year ahead would deliver more pain for risk assets as the Fed continued to hike, causing a major slowdown in earnings and a recession.
Fed over tightening would break the economy.
Well, the market is telling a different story through the first month of the year.
In the midst of 2022’s negativity that was expected to percolate through 2023, markets have been painting a bullish picture, clearing important technical resistance levels.
The S&P 500 is breaking above 4000, its 200 day moving average and a declining trendline that has capped the benchmark equity index’s upside on five occasions over the past 12 months.
Crude oil, industrial metals and other commodities have rebounded strongly – copper, the barometer for global growth is up over 30% from its 4Q low......iron ore, Australia’s largest source of export wealth, is up close to 60% during this period.
The pro-cyclical Australian and New Zealand dollars march higher, clearing the important physiological levels of 70 and 65 US cents respectively.
China’s re-opening, expectations of a less aggressive Fed, and hopes that an impending recession will be mild are the key narratives that are fuelling the risk on flows that originated in October.
Market participants seem oblivious to the fact that rate hikes take a long time to fully affect the real economy and financial markets. The fastest pace of rate hikes may take nine months or so before they are fully felt.
Market history tells us that we can see a major financial failure or a credit event occur towards the end of a Fed rate cycle.
Never before has the Fed had to shrink its balance sheet from such a high peak – scaling down from US$9 trillion is a monumental task......yet the current mood suggests markets seem oblivious to QT’s impact on financial conditions.
Whilst we may have higher to run in the short term, don’t get complacent.
How will the market trade over the coming weeks?
We’ll get some important answers next week and the week after.
The Fed, ECB and Bank of England all meet next week, 25bps expected from Jay Powell whilst the across the Atlantic 50bps is firmly priced from both central banks. We also receive US jobs numbers for January.
The US CPI report the following week will provide an important update for market participants’ economic and inflation views.
If risk assets trade higher through the other side of these events, its an impressively bullish signal of sustained upside through 1Q.
Or, it may prove to be the market’s zenith as global growth and inflation concerns re-emerge.
Returning our focus to the present, Tuesday delivered PMIs for the Australian, UK, eurozone and US economies – important forward looking indicators of manufacturing and services activity.
Whilst most PMI’s have delivered a sub-50.0 reading, remaining in contractionary territory, they have largely exceeded consensus estimates, indicating that economic activity is better then expected.
Of note, the eurozone services PMI jumped back above 50.0, this sector of the economy growing as Europe experiences a mild winter, driving a much needed rapid pullback in natural gas prices.
From late December NZDEUR price action has ranged between 0.5870 and 0.6000, the competing narratives of improved eurozone economic performance/hawkish ECB versus improving global risk sentiment muddying the outlook for the currency pair.
Tuesday’s highs marked in the 0.5980’s.
We may see a range breakout next week should the ECB surprise the market. Given the constant stream of hawkish ECB-speak from December onwards, the bar has been set high for another hawkish surprise.
The standout miss within Tuesday’s PMI suite was the UK services sector, printing at 48.0 (49.9 expected), it was the lowest reading in two years. Service providers have experienced a marked loss of momentum since December, with survey respondents citing higher interest rates and low consumer confidence as key factors that held back business activity.
Poking above 0.5266, the 50% Fibonacci retracement of the September to October aggressive downswing, NZDGBP reached its highest level since late September, poised for further upside.
We have been calling for a break above 0.5270 to shift to a more bullish outlook for the pair. Should we see follow through buying in the days ahead, we look for NZDGBP to test 0.5320 – an important technical resistance level that formed a double top back in August and September.
In the US the ISM PMIs are more widely followed over the S&P/Markit versions that were released overnight. Whilst both manufacturing and services PMIs remain firmly in contractionary territory, both exceeded consensus forecasts.
The US dollar has retreated through overnight trade propelling the Kiwi back through 65 US cents having logged Tuesday’s high through 0.6520 earlier in the day.
A re-test of last week’s high at 0.6530 a high probability through Wednesday.
It’s a big day regionally, CPI for both the NZ and AUS economies released. Local CPI is expected to ease further from 2Q’s 7.2% peak whilst across the Tasman, price pressures are expected to reach a new peak – annualised headline inflation reaching 7.6%.
Provided one or both reports deviate from consensus, expect to see pronounced moves for the antipodean cross.....NZDAUD peaked through 0.93 last week following a bottom forming near 0.9150.
We favour more settled, range bound trade through the remainder of 1Q.
The major offshore event is the Bank of Canada’s interest rate decision, market pricing assigning a 70% probability of a 25bps hike to 4.50%.
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Stuart Talman is Director of Sales at XE. You can contact him here.
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