By Stuart Talman, XE currency strategist
The mood has been bright to start the new week, market participants hopeful that congressional leaders will negotiate a solution to the debt ceiling impasse ahead of President Biden’s trip to Japan to attend the G7 meeting later in the week. Time is running out given Biden’s trip and scheduled recesses for both the Senate and the House.
US equity markets continue to trade in condensed ranges (last week was the tightest weekly range for the S&P500 since AUG. 2021) – the Nasdaq leading the way following news that European regulators had approved Microsoft’s acquisition of UK gaming company, Activision Blizzard for US$69 billion.
Tech stocks continue to outperform as short-term rates moderate, predicting the Fed will cut 2 to 3 times before the year is done.
Risk sensitive currencies lead the way on the G10 leaderboard, the Australian dollar the strongest amongst its major peers, gaining close to 1% to reclaim territory north of 67 US cents.
Commencing the new week near 0.6190, the New Zealand dollar ground higher through local trade and into the London morning before losing upside momentum around 0.6230. Buyers re-entered through the first half of US trade, lifting the Kiwi to an early morning high a pip or so shy of 0.6240.
The debt ceiling impasse, expectations of a Fed pause, US regional banking sector instability and a faltering China re-opening – these are the four major narratives that are influencing price action across asset classes.
Offsetting forces arising from these macro themes has spawned range bound, choppy conditions from late February…..market volatility is at astoundingly low levels given the multitude of issues faced by the global economy.
It’s a big week for Fed-speak, a deluge of FOMC officials share their latest thoughts on inflation, the macroeconomic data flow and the possibility of a Fed pause ahead of the next FOMC meeting on 14 June.
Fed Chair Powell’s participation in Friday’s panel discussion titled Perspectives on Monetary Policy is the major event to monitor for central bank watchers.
No less than four of Jay Powell’s FOMC colleagues were interviewed through Monday, all offering a similar message: inflation is still far too high, the Fed is not considering rate cuts until 2024 and they will continue to assess the lag effects of monetary policy via the incoming data flow.
The Fed and the bond market are misaligned.
The December Fed Funds futures contract currently contract prices in close to 75bps of cuts.
If the Fed is proven correct – the first rate cut occurs sometime in 1H 2024, the US dollar likely corrects higher as short term rates markets strip out 2023 cuts.
US dollar strength could then moderate through the back-end of the year given an absence of monetary easing would mean that the US economy has stuck its soft landing, or at worst experiences a short and shallow recession.
In this scenario risk sensitive currencies, including the Australian and New Zealand dollars outperform.
Year-end forecasts for the Kiwi to trade through 70 US cents may prove correct.
The counter argument is this: the Fed’s most aggressive tightening cycle in over 40 years will send the US and global economy into a deeper, more prolonged recession which may include a crisis of some description.
The Fed will be forced to rapidly reverse most of the ~500bps tightening to restore financial stability and prop up an ailing economy.
In this scenario, risk sensitive currencies will underperform amidst sustained global risk aversion……the safe-havens (USD, JPY, CHF), the strongest performers.
A history enthusiast, this author favours the second path.
History informs that avoiding a recession of material magnitude in the wake of aggressive monetary tightening is fanciful.
Shifting our focus back to the present, the markets fate over the next 24hours is likely in the hands of President Biden and House Speaker Kevin McCarthy. If meaningful progress occurs, US equities and other risk sensitive assets push higher.
Expect heightened volatility in the days ahead.
Regionally, RBA meeting minutes and key data points out of China are the focus.
Industrial production and retail sales releases follow a recent poor run of macro data, suggesting that China’s re-opening has not been as bullish for the global economy as expected. Last week’s trade balance data delivered a significant surprise contraction for Chinese imports, indicative of a global economic slowdown.
For the European session, UK jobs data and the second preliminary reading of 1Q eurozone GDP are the major releases.
UK wages growth spiked higher in March, a factor that compelled the BoE to hike by 25bps to 4.50%. Softer wages and headline jobs growth for April likely leads the BoE down a path to a pause at its next meeting on June 22.
US retail sales and Canadian CPI are the data points of note for the North American session.
Given Monday’s rebound, our attention is on a key resistance zone located between 0.6250 and 0.6280. The first hurdle to clear is the 50% Fibonacci retracement of the late April to 11 May rally, located at 0.6248.
Located near 0.6280, the 100-day moving average is the second important technical hurdle. If NZDUSD price action can rally back up through these hurdles through the next 48hrs, another challenge to 0.6380 likely ensues.
A debt ceiling deal is the obvious catalyst for this upside path.
We’re dubious a deal gets done before Biden leaves for Japan.
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Stuart Talman is Director of Sales at XE. You can contact him here.
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