Biden & McCarthy to meet this morning. Markets remain sanguine but volatility could spike should debt ceiling talks stall. Bar has been set high for RBNZ surprise following last week’s rates repricing

By Stuart Talman, XE currency strategist

In a week absent any high impact tier 1 data out of the US, the debt ceiling talks are likely to be the key driver of the market’s short-term direction. President Biden and House Speaker McCarthy are scheduled to meet at 0900 local time (1730 ET).

Last week the newsflow ebbed and flowed, initially reporting that Republicans and Democrats were making progress as negotiations were contained amongst a smaller cohort of congressional leaders. However, the headlines turned negative leading into the weekend, progress stalling due to Biden’s absence as the US president attended the G7 summit in Japan.

Whilst it’s a positive that Biden cut short the remainder of his trip, choosing not to visit Australia and Papua New Guinea, history tells us that both sides will be reluctant to conceded too much ground, typically drawing out a resolution to the 11th hour.

Republicans will not agree to a debt ceiling raise unless Democrats dial back some government spending programs.

We may well witness heightened volatility through the week.

A lack of meaningful headlines through Monday’s sessions has resulted in ultra-tight ranges.

Opening the new week near 0.6270, the New Zealand dollar’s price action has mostly been contained in a 20-pip range between 0.6270 and 0.6290.

The Kiwi was the standout performer amongst the G10 cohort last week, propelled higher by a hawkish repricing of NZ rates, the yield on the 2-year government bond climbing circa 50bps, logging one of its largest weekly gains in over 10 years.

Following on from the RBNZ’s surprise 50bps hike on 05 April, terminal rate expectations continue to be lifted. Back in February, the RBNZ forecasted the cash rate would peak at 5.50%. Currently at 5.25%, the OCR could reach 6.00% given the release of the Treasury’s budget last week, flagging large spending intent and a wider deficit.

Whilst 5.50% is now the consensus pick for the terminal rate, four of 21 economists in a recent Reuters poll called for the endpoint to settle at 5.75% or higher.

Market pricing factors in 30+ bps of hikes at tomorrow’s RBNZ meeting, thereby assigning an outside chance of a 50bps hike.

Given last week’s oversized surge in local bond yields as the local major banks upped their OCR track forecasts, the bar has now been raised for a hawkish RBNZ surprise. Even if the RBNZ were to deliver a half percentage point hike, NZDUSD is unlikely to commence a sustained run higher as offshore factors (the Fed, inflation, and the murky global growth outlook) remain the primary drivers.

We saw this play out following the April meeting. The Kiwi spiked higher, topping out near 0.6380 before retreating over the next few weeks to test the bottom of the current range, ultimately basing near 61 US cents.

The RBNZ could deliver a “dovish hike”, opting for the universally expected 25bps increment whilst flagging in both the statement and Governor Orr’s presser that the cycle is approaching an imminent pause.

Given the expected fiscal boost from the budget, rising net migration and the housing market faring better than expected, it may be a little too premature to put a pause on the table.

Whatever the outcome at 2pm tomorrow, its likely to be an eventful session for the antipodean cross. The Kiwi continues to reach higher versus the Aussie, NZDAUD logging Monday’s high a few pips shy of 0.9470, its highest level since a few days before Christmas.

The economics textbooks would favour a stronger AUD relative to the NZD given Australia’s more favourable fiscal position and current account surplus. However, a widening rate differential in favour of the Kiwi is the key driver of the short-term trend.

Whilst further upside beckons should the RBNZ keep its foot firmly planted on the tightening pedal, leading to a potential re-test of 2½ year highs near 0.9550, we suspect NZDAUD is nearing its summit.

Looking to the day ahead, its PMI day, S&P Global releasing the flash readings of manufacturing and services activity for the UK, eurozone and US economies. The common theme across all three of these major economies – industrial activity has been in recessionary territory for close to 6 months whilst the respective service sectors remain resilient, sustaining expansionary readings above 50.0.

The UK and eurozone S&P Global editions are likely to have more impact on short-term direction given the ISM PMIs are the more widely followed activity indexes in the US.

Following the PMIs, CPI for the UK economy is released tomorrow. Headline inflation is expected to drop from 10.1% to 8.3% - a sizeable decline as the base effects from higher energy prices drop out of the annualised calculation.

Should both the PMIs and CPI deliver downside surprises, the Bank of England is likely to join other central banks in halting its tightening cycle, maintaining the policy rate at 4.50% at its June 22 meeting.

The Kiwi has logged six consecutive up-days versus the pound, setting up for a topside breakout above key technical resistance around 0.5050, which also coincides with the 38.2% Fibonacci retracement of the 03 February to 26 April downswing.

Should price action consolidate above here in the days ahead, we likely see further upside and a test of both the midpoint of the range and 100-day moving average, located near 0.5100.

Although, with both the BoE and RBNZ nearing the end of their respective tightening cycles, expectations are for the pair to settle into range bound trade having rebounded over 3% from 14-month lows.

Expectations for the day ahead?

Given the market is keenly anticipating meaningful progress around the debt ceiling negotiations, we feel there is greater probability of the risk mood souring should the newsflow report otherwise.

As such, we suspect NZDUSD may struggle to make a decisive break above 63 US cents, instead favouring a move back into the mid to low 0.62’s.

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