Markets may continue to drift sideways before the action heats up tomorrow after the US Fed decisions. Ahead of that US equities pullback from highs, trading with caution

By Stuart Talman, XE currency strategist

The weak start to the week for risk assets continued through Tuesday’s Asian and European sessions, however risk sentiment has improved through US trade, US equities climbing on the softer than expected Employment Cost Index data point.

Having traded in a increasingly tight range over the past three trading days, the New Zealand dollar broke to the downside during the Asian afternoon, support at 0.6460 caving as weaker then expected retail sales across the Tasman weighed on the antipodeans.

It was a huge downside miss for the Australian economy, household spending in December plummeting by -3.9% (vs -0.3% expected), ending a streak of 11 consecutive monthly rises.

On face value, the result is shocking, the immediate conclusion being that Australian households are feeling the pinch as the RBA continues to tighten amidst price pressures that unlike other developed nations, continue to rise.

There does, however appear to be a seasonal impact from the rise in the Black Friday/Cyber week sales that results in a larger November result followed by a sharp decline in December.....a trend that has evolved over the past few years.

In any event, December’s poor result more than reverses November’s gain and does paint a picture of falling consumer spending.

The result brought more reprieve for the Kiwi against the Aussie, following last week’s aggressive downside surge, NZDAUD climbing to within a couple of pips of 0.9190. Should we receive a solid local jobs report today (1045), look for the pair to extend back up through 0.92.

The weak AUS retail sales number was offset by stronger than expected PMIs for China. Both the National Bureau of Statistics official Manufacturing and Non-manufacturing PMIs rebounded back into expansionary territory (a reading >50.0), buoyed by China’s abrupt end to its zero-Covid policy.

Despite more encouraging evidence regarding China’s re-opening returning economic activity to pre-pandemic levels, the data points failed to provide a boost to the China-sensitive New Zealand and Australian dollars.

The Kiwi’s slide continued throughout the Asian afternoon and European trade with losses accelerating in the London morning, overnight lows marked a few pips above 0.6410.

The major data point from the European session – the preliminary reading of 4Q eurozone GDP followed the recent trend for eurozone data, beating expectations. Expected to contract during 4Q (by -0.1%), the economy grew by a modest 0.1%.

Whilst the report was encouraging given the EU has managed to sidestep the worst scenarios for this winter, it was the slowest expansion since the first three months of 2021, domestic demand noticeably slowing due to high inflation and rising borrowing costs.

NZDEUR continues to trade in prevailing range that has constrained price action between 0.5880 and 0.6000 during the past 6 weeks. The pair traded an overnight low near 0.5920 before rebounding back through 0.5960 in early morning action.

We may get a range breakout through Thursday or Friday in the wake of the Fed’s and ECB’s interest rate decisions.

The most prominent market moving news story to come from Wednesday’s action has been the promising decline in the Employment Cost Index (ECI) for the US economy. A key input for the Fed’s policy equation, the ECI fell to 1% for 4Q, the third straight month of decline and below the market consensus forecast of 1.1%.

Whilst it is an encouraging result, providing further weight to the case that inflationary pressures continue to meaningfully recede, a 1% quarterly gain is still high by historical standards. Pre-pandemic, the ECI consistently printed south of 1%.

Prior to the release, US equity futures had been training in negative territory with losses shifting to gains following the open of cash markets an hour later. The S&P 500 and Nasdaq are up between 0.50% - 1.00% with a few hours of US trade remaining.

US stocks catching a bid pulled the Kiwi higher, NZDUSD improving back into the 0.6470’s,  the lower bound of the past week’s range.

Surely the second half of this week delivers a range breakout given it’s such a rare week in which both an FOMC meeting and the US jobs report are scheduled.

To the day ahead – it’s a frenetic day, the economic calendar delivering a multitude of market moving events.

Locally we receive 4Q jobs numbers – the unemployment rate expected to remain at 3.3% and wage growth expected to accelerate. The New Zealand labour market was on fire last year, marking new records for employment, participation, wage growth and the jobless rate.....the strong performance likely continued through the December quarter.

Today’s report in unlikely to have any monetary policy implications given there are more and more signs that labour demand will fall through 2023 as many businesses expect to reduce headcount amidst higher borrowing costs.

The risks are the downside, the Kiwi likely to fall further on a softer-than-expected jobs report relative to a potential rally on a strong outcome.

Offshore is when the action really heats up.....

The Fed’s interest rate decision drops at 0800 tomorrow morning followed by Fed Chair Powell’s press conference 30 mins later.

Powell’s presser will be the key, rather than the actual decision (25bps universally expected) or the statement. Should Powell choose to kick back against current market conditions, including the recent rally in US stocks and market pricing of 2H rate cuts, risk assets will likely plummet.

A busy US docket also presents ADP employment change and the more widely followed ISM Manufacturing PMI.

Across the Atlantic, the latest read on eurozone inflation is expected to deliver a third consecutive monthly decline – annualised inflation falling from 9.2% to 9.0% having peaked at 10.6% in October.

An upside surprise would ratchet up ECB terminal rate pricing, propelling the EUR higher.....a downside miss unwinds some of the ECB’s recent hawkishness – EUR lower.

We lean towards Powell wanting to avoid using language that will propel US stocks higher again, thereby inducing a pullback for risk assets....expectations are for the Kiwi to track back down to 64 US cents and perhaps lower.

It would be a surprise to see Powell deliver a message that the Fed has won the inflation battle and the tightening cycle is nearing its end-point. If we’re wrong – NZDUSD rockets through 65 US cents.

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