By Stuart Talman, XE currency strategist
Risk sentiment has improved through Tuesday’s sessions, the market adopting the view that a widespread banking crisis has been avoided and the Fed will dial back its aggression given the cracks that appeared via the Silicon Valley Bank and Signature Bank failures.
Whilst US CPI data has printed in-line with consensus forecasts, inflation is still far too high for the Fed’s comfort…..the titanic repricing in rates markets over the past few trading sessions could prove to be a misstep if Jerome Powell and his colleagues continue to prioritise inflation fighting over financial stability.
US equity markets were sharply higher during early US trade as beaten down regional banking stocks from the previous two sessions rebound and lead the broader market higher. The S&P500 was up around 1.70% whilst the rate sensitive Nasdaq up over 2%......gains have been pared heading into the New York afternoon.
Eye-watering bond market volatility continues, the yield on the monetary policy sensitive US 2-year bond rebounding over 40bps following a 100+bps plunge from Thursday’s peak. The yield on the benchmark 10-year has bounced from Monday’s low near 3.40% to trade near 3.70%.
Two weeks ago, the 10-year yield had moved decisively above the important 4.00% mark on the narrative that the Fed would continue to hike rates throughout 2H 2022 given persistently high inflation and a US economy displaying astounding resiliency.
The US dollar benefitted, ensuring that risk-sensitive currencies including the New Zealand and Australian dollars were standout underperformers through February and early March.
Marking last week’s lows in the 0.6080’s, the New Zealand dollar is on track to log a third consecutive day of gains, although net moves for Tuesday have been modest, much of the past 24hours price action has been contained in a 0.6200 – 0.6240 range.
The market has been fixated on financial stability concerns over the past few trading days, so much so that the number one global macro-economic data event – US CPI, has struggled to enter the periphery.
US core inflation came in a little stronger than expected at 0.5% MoM (vs 0.4% expected), slowing the annualised rate to 5.5% (as expected). Headline CPI printed in-line with expectations: 0.4% MoM, yielding an annualised rate at 6%.
Whilst tighter lending conditions will be a biproduct of the past few days turmoil, the Fed is likely to hike rates at next week’s FOMC meeting, opting for a 25ps hike rather than stepping back up to 50bps which had been the favoured outcome (via market pricing) following Powell’s hawkish testimony, mid last week.
Although it will be a tough decision, perhaps the toughest the Fed has faced during its most aggressive tightening cycle in over 40 years.
The Fed and other central banks must now choose between continuing the fight on inflation versus putting the financial system at risk. If the Fed chooses the former the cracks will widen, something will break…..if it prematurely ceases the tightening cycle given financial stability concerns it risks keeping inflation uncomfortably high.
Current market pricing assigns a ~70% chance of the Fed hiking 25bps to 4.75%-5.00% at next week’s FOMC meeting.
Analysts at Nomura are calling for a rate cut…..astounding!
This sudden divergence in views, driven by uncertainty caused by SVB’s and Signature Bank’s collapses, has caused a spike in volatility which is set to continue through to next Thursday morning’s policy update.
If Powell and his FOMC colleagues prioritise the inflation battle, the past few days re-pricing will be violently unwound, US bond yields and the dollar will rocket higher, US equities, the New Zealand dollar and other risk assets will plummet.
Conversely, the re-emergence of the Fed put and the possibility that the Fed’s tightening cycle has ended abruptly would likely drive the US dollar lower opening a path for the Kiwi to march back up to 65 US cents.
The Bank of England also meets next week. Widely expected to lift the policy rate by 25bps to 4.25%, prior to the SVB headlines, the UK central bank may favour a pause.
Tuesday’s UK employment report showed further signs of slowing wages growth, along with global financial stability concerns, adds weight to the case for a BoE pause. The bar us set relatively lower for an on-hold BoE relative to the Fed and ECB.
Over the past few weeks an NZDGBP double bottom has formed at 0.5184 providing a tentative signal that price action may feed back up into the 0.5150 to 0.5270 range that contained much of the past few months trade. The key near-term test for NZDGBP is 0.5150 resistance.
Looking to the day ahead, retail sales for China and the US are the two major events on the economic calendar. US banking sector headlines (or lack thereof) will also influence price action.
In the absence of negative news flow regarding regional US banks, expectations are for global yields to continue to rebound – we think the huge spike in bond prices (fall in bond yields) over the past few days overshot the mark.
Should this thesis prove correct, the US dollar should halt its slide leading to a New Zealand dollar that is unable to punch through important resistance at 0.6270.
A stronger than expected US retail sales number would also support this view.
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Stuart Talman is Director of Sales at XE. You can contact him here.
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