By Stuart Talman, XE currency strategist
In the wake of Friday’s monstrous US jobs numbers and strong ISM services PMI, risk assets continue to lurch lower, pulling back aggressively from recent prominent highs on the narrative that the Fed will continue to hike rates through 1H 2023.
US equities and pro-cyclical currencies, including the New Zealand and Australian dollars had rocketed higher to start the new year as market participants bought into the idea that the US economy is resilient enough to withstand one of the all-time most aggressive tightening cycles.
Well, that resiliency may be the market’s undoing – the Fed potentially forced to tighten well beyond a target Fed funds rate of 5%.......extinguishing the soft-landing hopes.
Commencing the new week treading water above 63 US cents, the New Zealand dollar range traded throughout local trade and into the London morning. NZD sellers re-entered the market as US trade kicked-off, driving NZDUSD to its lowest level in a month, marking Monday’s low at 0.6270.
It’s a stunning reversal from last week’s post-FOMC highs, the Kiwi’s three-day slide from near 0.6540 driving NZDUSD over 4% lower.
The Nasdaq has logged a similar sized peak to through reversal over the past three trading days, whilst the S&P500 has fallen over 2.5%, the Dow faring the best of the three bourses, losing less than 2%.
Why the big turnaround in sentiment and is this the start of another fierce, protracted sell-off?
Last week was monumental – a rare week in terms of the multitude of risk events that were crammed into one week.
Central bank decisions from the Fed, ECB and BoE, a flurry of tier 1 macroeconomic data releases, headlined by Friday’s US jobs report and a huge week of US earnings reports, lead by the tech behemoths – Apple, Amazon and Alphabet (Google).
Heading into the final sessions of the week, the major news story for the week was Fed Chair Powell failing to kick back against the recent easing in financial conditions. Implying a fabled goldilocks scenario in his FOMC presser, Powell took us down a path whereby the Fed implements one or two more hikes, holds the policy rate around 5%, and the US economy magically avoids recession as the brave knights of the FOMC sleigh the inflation dragon.
And they all lived happily ever-after.
Powell’s fairy tale ended following the release of Friday’s jobs numbers, the US economy adding over half-a-million jobs (vs 180K, expected), the unemployment rate falling to a new cycle low at 3.4%.
On Friday we wrote…..
Powell’s comments and answers have extended the window for the (misplaced) soft landing narrative…..this won’t change unless the incoming data flow runs too hot (meaning the Fed will have to return to peak hawkishness) or the data flow becomes recessionary (we ain’t gonna get a soft landing).
Friday’s employment report was far too hot!
Good news is bad news.
The strong data has lifted expectations for the Fed’s terminal rate, Fed funds futures moving back to pricing a peak above 5%. With US yields back on the rise, the dollar’s fortunes may be changing.
Although, it’s unlikely the dollar commences an aggressive ascent back to last year’s highs (near 115.00 for the dollar index).
Russia’s invasion, an impeding energy crises and China’s covid lockdowns – all factors that ensured 2022 was one the strongest years for the US dollar….it was the cleanest dirty shirt in the laundry.
With these factors no longer in play, or at the very least, posing substantially less risk, the dollar will likely struggle to attract the same buying momentum.
So, what does this mean for the Kiwi in the short to medium term?
The three day sell-off has pushed NZDUSD back down to the 200-day moving average and the 23.6% Fibonacci retracement of the October to January rebound. If the Kiwi can stabilise around these levels (mid to high 0.62’s) we favour a period of range bound trade ahead as the market digests the incoming data flow and re-assesses the Fed’s near-term policy path.
It would be surprising to see the Kiwi rip back below 60 US cents given the global growth outlook looks significantly better than 2H 2022.
What are we keeping an eye on this week?
Today’s major events are the RBA’s interest rate decision and Fed Chair Powell’s speech – will Powell strike a different tone to his FOMC presser?
In a quiet week for tier 1 data releases, Powell and other central bank speakers from across the globe will be in focus.
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Stuart Talman is Director of Sales at XE. You can contact him here.
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