By Stuart Talman, XE currency strategist
Risk sentiment continues to deteriorate as market participant climb the wall of worry and the early June "X-date" nears. Debt ceiling talks have stalled as negotiators have been unable to find middle ground, Democrats unwilling to agree to the level of spending cuts demanded by the Republicans. House Republicans have criticised Biden for his lack of urgency whilst a Democratic aide called out House Speaker McCarthy for his unwillingness to compromise across multiple disputed points.
We've been here before - political brinkmanship inevitably plays its role in drawing out a debt ceiling deal, fraying the market nerves as the unthinkable is considered.....
Will this be the first time in history the US government technically defaults?
The answer of course, will be a "no."
A deal will get done in the days ahead......likely early next week.
In the interim US equities and other risk sensitive markets trade with increasing signs of concern, the Nasdaq's and S&P 500's decline from recent 13-month and 9-month high respectively is approaching 3% with losses set to steepen through the week for as long as there is uncertainty that congressional leaders are progressing towards a deal.
Yields at the short end of the curve continue to rise as the odds of a US default increase, despite history telling us that this is unlikely to occur. Tech stocks struggle in a rising yield environment; therefore, the broader market is at risk of a sizeable decline given its reliance on the notable year-to-date performance of megacap tech stocks.
Fear, uncertainty, a souring mood......the New Zealand dollar underperforms when these are the prevailing sentiments.
Wednesday has delivered the largest intraday decline for the Kiwi since the depths of the covid despair, fear and panic in March 2020.
The Kiwi has cratered, falling almost 2.5%!
The next worst performer amongst the G10 cohort - the Australian dollar, declining just over one percent.
The primary catalyst has been the RBNZ's dovish hike, the key developments:
- RBNZ hikes rates by 25bps to 5.50%
- 5-2 vote split (2 members voted for a pause)
- OCR track not changed from FEB. forecast
- RBNZ maintains 5.50% terminal rate
Whilst a quarter-percentage point hike was widely expected, a few analysts had predicted
that following the release of last week's budget, the RBNZ may opt for another 50bps hike
as they did at the April meeting.
There was to be no hawkish surprise, instead the RBNZ delivered multiple surprises that
ultimately characterised this policy update as a "dovish hike."
The first surprise was the 5-2 vote.
The RBNZ typically does not publish voting details. Whist analysts thought board members would be making a choice between 25bps vs 50bps, the split was in fact a call between 25bps and no-change, 2 members preferring to keep rates on hold.
The second surprise was delivered via the OCR track.
Back in February, the RBNZ projected a terminal rate at 5.50%.
Last week's hawkish repricing in domestic rates markets came about due to expectations that the endpoint of the cycle would be closer to 6% given the stimulatory budget and other factors, including stabilising house prices and a net-migration step-up.
However, the RBNZ made no change to its OCR track, maintaining its projected cycle peak at 5.50%.
The message sent yesterday - we're now pausing.
Finally, the third surprise was the overall tone of the statement - balanced and clearly more dovish than most analysts, if not all, had expected. Whilst the RBNZ did acknowledge the recent trend of rising net-migration, comments were provided regarding the uncertainty of this trend's inflationary impact. Regarding fiscal policy and the budget, the bank noted it would be less contractionary relative to previous expectations.....a balanced take on the budget's potential to stoke inflation.
Prior to the release of the decision and accompanying statement, NZDUSD was trading near 0.6260. Immediately following is plummeted to 0.6170. Selling pressure has not eased through the offshore sessions, the Kiwi falling below 61 US cents for the first time since early March.
We're now at a critical support level. Should price action extend below 0.61, we likely see a test of the midpoint October - February rally, located at 0.6025.
In other news from Wednesday, UK CPI came in much hotter than expected. Whilst headline inflation dropped from 10.1% to 8.7%, the result was well above the consensus of 8.2%. Most of the decline was attributed to base effects - the 50% surge in energy prices 12 months ago, dropping out of the annualised calculation.
The core rate climbed from 6.2% to 6.8%, a new cycle high.
The Bank of England has a big problem.
The April CPI report raises concerns that inflation is now a structural issue for the UK economy requiring further tightening from the BoE. The pound weakened versus the dollar against the rationale that a prolonged BoE tightening cycle increases the likelihood of an ugly UK recession.
Having failed near 0.5050 resistance, NZDGBP has fallen over 2.5% over the past two trading days, logging overnight lows near 0.4930. Given the UK are clearly failing to rein in inflation, the Kiwi should stabilise and recover.....likely following improving risk sentiment as a debt ceiling deal is agreed.
Looking to the day ahead, the next reading of 1Q US GDP, initial jobless claims, PCE and Fed-speak are the scheduled events that may influence short term direction.....but really, it remains all about the debt ceiling newsflow.
We suspect another day will pass without meaningful progress reported......Kiwi to remain under pressure.
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Stuart Talman is Director of Sales at XE. You can contact him here.
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