Soft PMIs: manufacturing contracts further, services growth slowing. US equity markets end their winning streak amid sentiment shift. NZD extends lower

By Stuart Talman, XE currency strategist

A potent mix of central bank aggression and soft macroeconomic data flow induced a week of deteriorating risk sentiment, aversion flows intensifying through Friday's sessions.

Mostly weaker-than-expected "flash" PMI readings for the US, UK , EU and AUS have reminded investors of the fragile growth outlook, compelling market participants to abandon risk assets into the week's close.

US equity markets have ended their impressive streak of weekly gains, the Nasdaq's weekly decline of -1.4% ending an 8-week run. Despite a week of softness, the tech-heavy index is still up over 35%, year-to-date, fuelled by AI hysteria and expectations the Federal reserve will shortly end its most rapid tightening cycle in over 40 years.

Shedding -0.8% during Friday's session, the S&P500's weekly loss of -1.3% ends a five week winning streak. Year-to-date, the broader index has gained over 13%.

Many a market talking head (including this one) projected a turbulent year for global equity markets, economic activity expected to rapidly deteriorate amidst combative synchronised global monetary tightening. The Fed and its central bank peers battle to rein in multi-decade high inflation would result in significant pain for households and businesses, eventually breaking something.

Whilst cracks started to appear via the failure of a small group of US regional banks and the evaporation of Credit Suisse, a larger, more widespread global banking crisis was averted.

One of the most widely anticipated global recessions has yet to materialise.

And, whilst Friday's PMIs report that manufacturing activity continues to fall further into recessionary territory across most major economies, the service sectors of these economies continue to grow, albeit at a slower pace.

During the pandemic, households bought a lot of stuff.

Post-pandemic, we're back out and about, travelling, socialising, dining out, going to concerts.

Hence why manufacturing PMIs sustain contractionary readings below 50.0, whilst services PMIs remain in expansionary territory, north of 50.0.

Amongst a sea of PMI misses, the eurozone readings were the noted laggards. Logging an 11th consecutive month of contraction, it was the sharpest decline in EU factory activity in over 3 years. Whilst services activity expanded for the sixth month in-a-row it was the slowest pace of growth in 5 months.

The sub-gauges which measure employment demand, new orders and prices were softer across the board whilst the future expectations component also dipped, falling to its lowest level this year amidst waning optimism.

The New Zealand dollar had been under pressure in the run up to the eurozone and UK PMIs, falling from 0.6190 to 0.6140 during the Asian afternoon.  Further downside ensued through European trade, NZDUSD marking two week lows a few pips below 0.6120.

The Kiwi tracked sideways in a choppy US session, ending the week near 0.6140 - a weekly decline of -1.33%. The Australian dollar was the weakest performer amongst the G10 cohort, shedding -2.89%; AUD headwinds coming via dovish RBA minutes, softer metals prices and underwhelming China stimulus.

Gaining +1.41% for the week, NZDAUD rebounded off major support near 0.9050 to end the week around 0.92. Against its other major peers, the Kiwi was softer, logging a marginal weekly decline versus the JPY, shedding around two-thirds-of-a-percent against the GBP and over 1% against the EUR.

Last week has delivered a noted shift in sentiment following the June risk rally, leaving market participants wondering if a deeper correction is evolving.

Rebounding from a year-to-date low at 0.5985 on the last day of May, NZDUSD topped out a couple of pips shy of 0.6250 the week prior. Trading back through the mid-point of the past four month's range, we're still none-the-wiser regarding the Kiwi's next key directional move.

On the risk positive side, whilst there are clear signs that higher borrowing costs are impacting certain sectors of the global economy, labour markets across the globe remain tight and resilient, fuelling the narrative that a deep and protracted global recession will be avoided.

Household spending, although softening remains at non-recessionary levels as do company earnings…..the demand shock that many predicted for 2023 has not occurred.

On the risk negative side, inflation, whilst receding (ex-UK), remains uncomfortably high. The past week delivered surprise 50bps hikes from the Bank of England and Norges bank, following on from the Bank of Canada ending its 5 month pause and the RBA's non-consensus 25bps hike earlier in the month.

History tells us that when inflation reaches ultra-high levels, it takes many, many years to return to targeted levels. A study by Havranek and Ruskan (2013), in which they conducted a meta-analysis of 67 published studies on global inflation and monetary policy, found that when CPI breaches the 8% threshold (as happened in many economies, last year), the median time to revert to 3% is nearly 11 years.

That's no typo…. history informs it will take over a decade to return inflation to targeted levels!

Most central bank forecasts project inflation returning to 2% in 2025, just three years after the commencement of the respective tightening cycle.

Whilst many of us are too young to have experienced the hyperinflation of the late 70's and early 80's, central bank officials are attuned to the debilitating outcomes that rampant inflation causes, and therefore will keep the foot firmly planted on the tightening pedal until demand ratchets down to a level that returns CPI to 2%.

Whilst widespread job losses have yet to materialise, they inevitably will.

Monetary policy takes some time to filter through the economy, some studies show lag effects are around 18 months. From this point, job losses accelerate, demand cools, earnings fall, the economy drops into recession.

We're currently 15 months on from the Fed's first hike.

Last week's economic calendar was light on tier 1 macroeconomic data releases, as is this weeks.  The action steps-up through the first two weeks of July, headlined by US jobs numbers (NFP) on 7th and US CPI on the 13th.

Should NFP and CPI surprise to the upside, the market will likely align with the Fed's dot plots, pricing in an additional two hikes. Risk assets will fall, the Kiwi likely re-tests sub-0.60 levels.

Downside data misses (softer jobs, softer inflation), the tech fuelled equity market rally marches on, lifting NZDUSD back through the mid to high 0.63's.

Before these key data points drop, we may see profit-taking price action as the month, quarter and half-year draws to a close.

Looking to the week ahead, the major data events include AUS retail sales, US and UK GDP, China PMIs and CPI reports for Australia, Canada, Japan and the eurozone.

Regarding central bank watch, the ECB holds its annual Forum on Central Banking in Sintra, Portugal. An all-star lineup of officials including Powell, Lagarde, Ueda and Bailey will be participating in panel discussions.

The markets attention will also be fixated on developments in Russia, following the weekend's abandoned military uprising. Bloomberg reports:

In a bewildering 24 hours, a transfixed international audience watched troops loyal to Russian mercenary Yevgeny Prigozhin advance hundreds of miles toward Moscow at breakneck speed only for him to suddenly call off the assault and agree to go into exile with all charges dropped in a late-night deal.

The rapid chain of events left the US and Europe puzzling over the political implications of a rebellion that shattered Putin’s invincible image as Russia’s leader. The crisis unfolded amid bitter divisions in Russia over the faltering war in Ukraine that’s the biggest conflict in Europe since World War II, as a Ukrainian counteroffensive continues to try to push Russian forces out of occupied territories.

Risk assets do not perform well when uncertainty reins. Should the situation in Russia escalate, expect a sure to the downside.

We suspect the Kiwi continues to trade with a downside bias this week. Friday's retreat has pushed NZDUSD below the 200-day moving average with lows marked a pip or so away from 0.6116, the 50% Fibonacci retracement of the June rally.

Price action must stabilise above 0.61 and trade back through the 16 June high near 0.6250 to shift short-term bias to positive.

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