US ISM Services PMI stronger than expected – no recessionary signs. US treasury yields fall, stocks rise as the week ends with a 2-day risk rally. US jobs numbers and Powell’s testimony are the weeks’ major events

By Stuart Talman, XE currency strategist

In a week of two halves, risk assets shrugged off negative risk sentiment to end the week on a stronger footing, signalling rising comfort levels with the higher yield, higher terminal rate environment.

The first half of the week saw US equities and other risk sensitive assets, including the New Zealand dollar, driven lower as US bond yields extended higher. Plumbing the week’s low a pip or so above 0.6130 on Monday, it seemed the Kiwi was destined to extend lower as the yield on the benchmark US ten-year bond ascended through the psychologically important 4.00% mark.

Puzzlingly, this was not the case, US equities roaring higher through the final two days of the trading week, the shift to positive risk sentiment propelling NZDUSD back to within reaching distance of 63 US cents before ending the week near 0.6220.

The recent run of stronger than expected macro data out of the US has been bad news for US stocks as market participants worry that renewed hawkishness from the Federal Reserve will derail the US economy, dashing hopes of the fabled soft-landing.

Terminal rate expectations have climbed from below 5% to now reside at 5.50%, with some market talking heads calling for a 6% end point to the Fed’s tightening cycle given recent key inflation reads have surprised to the upside.

Having stepped down to a 25bps hike in February, expectations for a step back up to a half-a-percentage point hike at the 22 March FOMC meeting are still low, but have been creeping higher over the past fortnight, swaps markets now assigning a 25% probability.

Such a move would spell trouble for US equities, likely causing a larger downside washout.

The major data point from Friday’s US session was the ISM Services PMI.

Whilst the headline number of 55.1 cooled from the January reading of 55.2, the result was hotter than expected (54.5), indicative of a services sector that is yet to show any meaningful slowing in activity following the Fed’s 450bps of tightening.

Given inflation remains front and centre, the prices paid component of the headline number is closely monitored – price pressures eased (65.6 vs 67.8) from the January reading…..some market commentators attributing this sub-gauge’s result as the catalyst for Friday’s rally.

The immediate reaction to the stronger-than-expected headline ISM number was stronger yields/stronger US dollar; weaker US stocks/weaker pro-cyclicals – the Kiwi slipping back below 62 US cents.

However, the market’s mood brightened throughout the New York afternoon, US equities resuming their 2 day-rally, snapping a three-week losing streak. Bouncing off the 200-day moving average at Thursday’s lows, the S&P500 added another 1.62% during Friday’s session to end the week close to 2% higher.

Logging its best day since early February, adding close to 2%, the Nasdaq logged a weekly gain of 2.58%, a remarkable effort for the rate sensitive tech index given US bond yields continue their ascent.

Although, encouragingly for US stocks the 10-year yield was unable to close the week above 4.00%, a tentative sign that the upside surge for yields may be losing momentum.

If this proves to the be the case, US dollar price action will shift from its rebound phase into a consolidation phase as the market contuse to assess the ongoing resiliency of the US economy.

The New Zealand dollar was the strongest performer of the G10 currencies this past week, NZDUSD logging a weekly gain just north of 1%, closely followed by the EUR and GBP. Weaker than expected GDP and monthly inflation data points earlier in the week ensured the Australian dollar sat in the middle of the pack, logging a weekly gain of ~0.65%.

Looking to the week ahead – it should prove to be action packed!

It’s a huge week for the latest readings on the US jobs market, JOLTS Jobs openings and ADP Employment change on Thursday evening the curtain raisers to the non-farm payrolls/US employment report on Friday.

You will recall that the January non-farm payrolls data point was a stonker, easily exceeding expectations to print north of 500K new jobs. Expectations for February’s number is around +200K.

Will the January result prove an outlier or will the US labour market continue to defy the most aggressive tightening cycle in over 40 years?

The answer to that question during the final session of the week will likely dictate the path for US stocks and other assets over the next couple of weeks.

The other major event for the week is Fed Chair Powell’s testifying before a U.S. Congressional committee on Tuesday. His comments will be analysed for any signals regarding the Fed’s choice between a 0.25% or 0.50% hike at the FIMC meeting later in the month.

Regionally, the two big events for the week are interest rate decisions from the RBA and BoJ. Whilst the latter is not expected to shift policy settings, it will be the last monetary policy meeting for outgoing BoJ Governor Kuroda.

The market is grappling with a potential shift to more hawkish BoJ policy under new governor, Ueda.

The RBA is widely expected to hike 25bps to 3.60% but may signal they are nearing a pause given the recent (relative) softness in labour market and inflation data.

It’s a quiet week for local data releases – no tier 1 events.

Markets seem a little confused.

Bouts of negative risk sentiment driven by higher for longer concerns give way to periods of positive risk sentiment as the soft-landing camp buy the dips.

This week may provide a clearer picture as to the next key directional move…..which may well be sideways.

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