By Stuart Talman, XE currency strategist
Risk assets have benefitted from a broadly in-line US CPI report, rallying on the likelihood that tomorrow's FOMC meeting will end the run of 10 consecutive interest rate hikes.
The S&P500 and Nasdaq rallied for a fourth consecutive day whilst the underperforming Dow plays catch-up, logging a sixth day of gains.
A little over two weeks ago interest rates futures assigned an implied probability of close to 70% the Fed would hike by 25bps to 5.25%-5.50%. Following the CPI release, this has further fallen from around 20% to ~5%.
The Fed pause or skip (should a July hike occur) looks like a done deal.
Finding support near 0.6110 during Tuesday's local session, the New Zealand dollar was bid throughout the Asian afternoon, improving through 0.6150 before trading in a tight range ahead of the inflation numbers.
Immediately following the release, the Kiwi spiked higher to within a couple of pips of 0.6180, reaching its highest level since the RBNZ's dovish hike on 24 May. Rounding into the closing stages of US trade, gains have been pared as US bond yields stage a notable recovery from their CPI induced lows, NZDUSD easing back below 0.6150.
US consumer price inflation for May did not deliver any meaningful surprise to the consensus estimates. The core reading (ex- food and energy) printed at 0.4% MoM / 5.3% YoY (0.4%/5.2% expected), the slowest annualised rate since November 2021. Headline inflation delivered a marginal downside miss: 0.1% MoM / 4.0% YoY (0.2%/4.1% expected).
May's CPI report should allow Jerome Powell and his FOMC colleagues to hold rates steady at 5.00%-5.25% as they continue to assess the incoming data flow, in particular inflation and jobs numbers.
Whilst it is encouraging to see further easing of price pressures (core rate declining from 5.5% to 5.3% having peaked at 6.6% in SEPT.), the uncomfortable reality is that inflation is still far too high with more work to be done to enable a return to the Fed's 2% target.
The Fed will resume their tightening cycle in July should the macroeconomic data flow continue to represent a stubbornly resilient US economy. An unemployment rate remaining below 4% in addition to sustained sold jobs growth is at odds with CPI declining to 2%.
In other news from Tuesday, the pound continues its run as one of the strongest performing G10 currencies, GBPUSD logging an intraday gain of around three-quarters-of-a-percent, supported by a solid UK employment report.
The unemployment rate ticking down from 3.9% to 3.8%, was comfortably below the consensus of 4.0%. In addition, headline jobs growth of 250K in the three months to April surpassed expectations of 162K, rising from 182K in the previous period.
Finally, weekly earnings (including bonuses) rose by an annualised 6.5%, again easily exceeding the consensus forecast whilst regular pay (ex-bonuses) grew at the fastest pace since June 2021.
It’s the marked increase in wages growth that will keep the BoE's foot firmly planted on the tightening pedal, ensuring the policy rate is raised through 5% following likely 25bps hikes at the 22 June and 03 August monetary policy meetings.
Market pricing is ultra-hawkish, calling for an additional 120bps of tightening.
Attempting to break through resistance near 0.49, NZDGBP has tipped over, retreating to the 0.4870's.
Given the market's aggressive outlook for BoE tightening, last month's white-hot CPI report and yesterday's jobs numbers, the bar is now set very high for additional hawkish surprises. We therefore favour mild NZDGBP upside, improving back into a 0.4900 - 0.5000 range as we head into 2H.
Looking to the day ahead, the focus will be on the week's second major event: the FOMC meeting. The widely expected on-hold decision, accompanying statement and dot-plots are released at 6AM followed by Fed Chair Powell's presser, 30 minutes later.
The dot-plots and tone of Powell's presser will determine whether the market interprets the outcome as a dovish or hawkish pause. Should the dot-plots suggest the majority of FOMC members favour additional tightening whilst Powell kicks back against the view that the terminal rate is now in place, risk assets will come under pressure.
Alternatively, if Powell places too greater emphasis on easing inflation and softening in some labour metrics, thereby suggesting the Fed is done, US equities and pro-cyclical currencies, including the New Zealand dollar continue their march north.
We favour the statement, dot-plots and FOMC press conference leaning hawkish, but given Powell will refrain from forward guidance, it's unlikely there will be an explicit promise of additional tightening.
If this proves to be the outcome, we look for NZDUSD to ease back towards 61 US cents.
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Stuart Talman is Director of Sales at XE. You can contact him here.
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