By Stuart Talman, XE currency strategist
The run of stronger than expected US data continued through Friday’s session, the Fed’s preferred inflation gauge, Personal Consumption Expenditure (PCE) exceeded expectations, adding to the increasing the likelihood the Fed hikes by 25bps at its March, May and June meetings.
In response, US equities and other risk assets, including the New Zealand and Australian dollars were forcefully sold, although US stocks pared losses into the week’s close, a sign that buy-the-dippers have not been discouraged by recent developments.
Declining -1.0% and -1.7% respectively for Friday, the S&P500 and Nasdaq logged their worst weekly performance since mid-December, shedding -2.7% and -3.3% for the week.
The New Zealand dollar was one of the worst performers amongst the G10 cohort, shedding 1.00% to end the week near 0.6150, its lowest level since late November. Only the AUD (-1.20%) and the JPY (-1.32%) logged larger falls , Friday.
Having fallen below major support at 0.6190, NZDUSD looks vulnerable to a downside capitulation should the market’s mood fail to brighten.
Sentiment has clearly shifted throughout February following a prematurely bewildering January risk-rally.
Market participants have been departing soft-landing island in droves over the past few weeks, forced to rethink the path for Fed policy during the first half of 2023 whilst questioning their over-confidence that inflation was no longer a problem given its downward trajectory through the latter stages of 2022.
The PCE data was hot. Annualised core PCE rose 4.7%, jumping from the upwardly revised 4.6% and above consensus estimates of 4.3%. Higher price pressures align with what was seen in the CPI and PPI reports, signalling that prices are not cooling as much as hoped.
The disinflationary trade is dead.
The data propelled US bond yields higher, the yield on the US ten-year matching Thursday’s high through 3.97%. The market’s jitteriness will ratchet up this week should the psychologically important 4.00% mark be breached and form new support.
At the shorter end of the curve, the yield on the two-year bond, which is more sensitive to expectations for Fed policy, climbed through 4.84%, its highest level since 2007.
The surge higher in US yields represents a Fed that must keep hiking through 1H and hold the policy rate at its peak for longer. Heading into the new year, the market had adopted the view that the Fed would pause after one (maybe two) more hike to then commence cutting rates during 2H.
The market was wrong.
Don’t fight the Fed.
One important question for the market – will the Fed be compelled to step back up to a 50bps hike?
Market pricing has been climbing throughout the past week, now assigning a 35% probability to a half-a-percent hike at the 22 March FOMC meeting.
Should the theme of upside US data surprises continue, specifically non-farm payrolls (jobs) and inflation (CPI), it will be a line-ball call in March.
Via last week’s release of the FOMC minutes and recent Fed-speak, we have learnt that a few FOMC voters favoured a 50bps hike at the February meeting. The numbers in the 50bps camp will swell should annualised core CPI for the US economy remain near 6.0% (released 14 MAR.).
Fed fund futures now price a ~5.40% terminal rate (policy rate currently at 4.50%-4.75%), therefore calling for close to an additional 100bps of hikes across the next three FOMC meetings, implying that one of the decisions will be a 50bps increment.
Should terminal rate expectations continue to edge closer to 6% as the incoming activity data flow remains elevated (relative to expectations) and inflation data fails to recede, risk sensitive assets likely continue to track lower.
The worst-case scenario being stubbornly high inflation whist the activity data (jobs, household spending, PMIs) starts to deteriorate…..October cycle lows likely to be challenged against this stagflationary backdrop.
The New Zealand dollar would settle into a range somewhere in the mid to high 0.50’s.
Logging a weekly decline of -1.30% against the dollar, the Kiwi fared better against its mother major peers, smaller declines against GBP (-0.44%) and CAD (-0.30%), whilst gaining against the EUR (0.14%) and JPY (0.43%).
The past week’s largest gains occurred against the Aussie dollar, NZDAUD gaining just shy of 1%, climbing back through 0.9150. The RBNZ maintaining the projected peak OCR anear 5.5% whilst hiking by another 50bps to 4.75%, supporting the rate sensitive antipodean cross.
Should the risk backdrop remain negative leaning, the Kiwi likely continues to outperform in the short term given the Aussie’s risk-proxy status.
We may see 0.92 tested this week.
What are we keeping an eye on this week?
Locally, today delivers 4Q retail sales for, expected to yield a +1.7% gain following on from a +0.4% gain for 3Q.
Later in the week we receive the latest consumer confidence data for Kiwi households.
Regionally, AUS retail sales and GDP, and PMIs for China are the major data points.
The major events for the week include the latest reading on eurozone CPI and the more widely followed (relative to the S&P Global PMIs) ISM PMIs for the US economy.
The newly nominated Bank of Japan Governor Kazuo Ueda will be giving a speech today, widely followed for any signals regarding further easing of the BoJ’s ultra-easy monetary policy settings.
At the start of last week, we favoured a lower New Zealand dollar – we will maintain this view.
The key near-term technical support level to monitor is the 38.2% Fibonacci retracement of the October upswing, located at 0.6146. Should price action extend below here as a further deterioration in risk sentiment forces US stock lower, this week may force a test of the 50% Fib at 0.6025.
Tempering the downside bias, momentum indicators have tracked into oversold levels and the dip buyers may come out in force this week…..look for the Kiwi to find support above 61 US cents to tentatively signal the February retreat is exhausted.
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Stuart Talman is Director of Sales at XE. You can contact him here.
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