US PCE prints stronger than expected probability of a Fed hike above 60%. And US debt ceiling deal agreed; next step is to pass legislation through Congress

By Stuart Talman, XE currency strategist

After weeks of political brinkmanship news has broken over the weekend that negotiators have reached a debt ceiling deal. Whilst its extremely encouraging that congressional leaders have taken an important step towards avoiding a catastrophic default the job in only half done.&

The next step is to pass the legislation before the revised June 5 default deadline – congressional leaders must convince enough of their respective party members that the agreement is a better alternative to the dire economic consequences of default.

There is plenty in the agreement that either side will not like.

Whilst the positive news is likely to boost risk sentiment to start the new week, the risk remains that entrenched political divisions and time-consuming administrative requirements pushes the process beyond June 5.

The risk sensitive New Zealand and Australian dollars may open firmer this morning, although it was expected that meaningful progress would be made over the weekend given Monday is the Memorial Day holiday in the US.

One of the major stories from last week was the dynamic of rising US stocks in tandem with a rising US dollar.

Typically, US equity markets will struggle in a stronger-dollar environment (remember the first 10 months of 2022), however this correlation broke down last week as the dollar climbed on both debt ceiling concerns and a substantial re-pricing of Fed policy expectations whilst US stocks were catapulted higher by an AI-lead tech rally.

The New Zealand dollar was the notable laggard, logging a large weekly decline of close to 4% as the RBNZ’s shock dovish hike added to the Kiwi’s woes. Weekly losses of around 3% were logged against the EUR, GBP and CAD, whilst dropping around 1.80% versus the AUD and JPY.

Plummeting to its lowest level since early November, selling pressures eased through Friday, NZDUSD logging an intraday loss of around a quarter-of-a-percent to close near 0.6050, near the week’s lows.

We’ll be monitoring 0.6025, the 50% Fibonacci retracement of the October to February rebound – our near-term technical support level that may halt the Kiwi’s slide. Friday’s low was marked a few pips above 0.6030.

RBNZ dovishness aside, the other catalyst for the Kiwi’s downside rip has been the hawkish re-pricing of expectations for the Fed funds rate through the second half of 2023. Whilst a Fed pause is likely to occur over the next two or three FOMC meetings, market pricing now assigns a 60%+ probability the policy rate is lifted 25bps to 5.25%-5.50%.

A week ago, this probability sat below 20%.

A few weeks back, the market was pricing in over 100bps of cuts before year-end.

Now, there is less than a conventional 25bps cut represented via the December Fed funds futures contract.

Higher US rates along the yield curve have propelled the dollar index (DXY) back through 104.00. Back in April and early May, calls for the dollar’s demise as the globe’s reserve currency and a prolonged period of dollar weakness were deafening.

The dollar bears now in hibernation.  

A recent run of stronger than expected US macroeconomic data has also supported the greenback.

Should the dollar keep rallying the next major upside test for the DXY is 105.80 resistance. A decisive break through here would likely cause great concern for US equity markets, derailing the tech rally amidst a higher yield environment.

We suspect the dollar’s rally may lose momentum given the bar has now been set considerably higher for further hawkish surprises…..the DXY to tip over before it could re-test 105.80.

Looking to the week ahead, in a holiday shortened week in the US, the headline event is the May jobs report. Jobs growth is expected to fall below 200K whilst the unemployment rate is projected to tick up from 3.4% to 3.5%. A soft report may tip the scales back in favour of a Fed pause at the 14 June meeting.

Other data points of note from the US include ADP employment change and the ISM Manufacturing PMI.

PMIs for China drop on Wednesday. Should the run of soft China-data continue, look for further CNY weakness feeding into a weaker NZD and AUD, the latter impacted more.

Eurozone CPI and GDP for Canada the other two tier 1 macroeconomic data releases.

It’s a quiet week for local events, absent any volatility inducing data points.

Following last week’s pummelling, we expect the Kiwi to base around 60 US cents as concerns over the debt ceiling abate. Additional Fed hawkishness is now priced in…..we could see a scenario whereby NZDUSD recovers back to 62 US cents should we receive a soft US employment report.

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