By Stuart Talman, XE currency strategist
Following two days of selling, risk assets have rebounded through Tuesday's sessions, US equity markets advancing on strong data beats across multiple tier 2 releases whilst China sensitive assets, including the New Zealand and Australian dollars benefitted from a stronger yuan.
Having logged intraday declines in 5 of the past 6 trading days, the S&P500 and gains close to 1% whilst the Nasdaq leads the way, adding over one-and-a-quarter percent. The two major equity indices had pulled back from fresh 52 week highs during this period amidst renewed central bank hawkishness and recession fears driven by a run of soft macroeconomic data flow.
US housing data, durable goods orders and consumer confidence have all exceeded expectations during Tuesday's US session, reminding market participants that despite the Fed's 500bps of tightening, the US economy remains resilient in most sectors.
For now, the market is cheering upside data beats, however this may change as the data flow out of the US intensifies over the next two weeks with critical inflation readings and US employment numbers dropping in the first two weeks of July.
A stronger-than-expected non-farm payrolls (jobs growth) result on 7 July in addition to a hot PCE number this Friday and hot CPI on 12 July would send US equities and other risk-sensitive assets into a tailspin, leading the market to hawkishly reprice expectations for the near-term path of Fed policy.
At the mature stage of the most aggressive tightening cycle in 40+ years, the market's current view is the Fed will likely hike one more time on 26 July, lifting the Fed funds target rate to 5.25%-5.50%. The policy rate will then be held steady at its peak until the US economy cools to a level that requires the Fed to commence its easing cycle.
Fed funds futures project Jerome Powell and his FOMC colleagues will commence cutting the policy rate in 1Q 2024.
Market pricing via Fed funds futures currently assigns close to an 80% implied probability of a 25bps hike at the July FOMC meeting and close to 70% of an on-hold decision at the 20 September meeting.
Most FOMC officials, on the other hand, are projecting at least 2 more hikes, sighting persistently high inflation and sustained labour market tightness as two ongoing trends that require the Fed to maintain a tightening bias.
Whilst they would never publicly state it, aggressive monetary tightening must ultimately deliver significant job losses to cool the US economy and in turn, drive inflation back to the Fed's 2% target.
Whilst the unemployment rate in the US has ticked up from a cycle low of 3.4% to last month's reading at 3.7%, the reality is this must track materially higher to rein in multi-decade high inflation.
Via their most recent set of dot-plots (released at the 14 June FOMC meeting), the Fed's median projection is for the jobless rate to climb to 4.5% by the end of 2024.
The message is clear from the more hawkish Fed officials, the Fed funds target rate is not yet sufficiently restrictive to facilitate the desired cooling in economic activity.
The US dollar has based over the past couple of weeks having retreated through the first half of June on the narrative that the Fed was almost done and the US economy looks well placed (at present) to avoid a deep and protracted downturn.
Having peaked near 0.6250 on 16 June, the New Zealand dollar has shed around 2% as poor sentiment regarding the China growth outlook also weighs on the risk-sensitive Kiwi. Recovering off Friday's low a few pips below 0.6120, NZDUSD has logged a second day of modest gains, improving back to 62 US cents before pulling back through 0.6170.
Price action has been choppy through Tuesday's sessions, NZDUSD springboarding through the Asian afternoon from 0.6160 to log an intraday high a pip or so through 0.6200. The catalyst for the Kiwi's bid - a much stronger than expected daily fixing rate for the CNY.
A clear sign that the Chinese monetary authorities are uncomfortable with the depressed level of the CNY (USDCNY reached a 7mth high near 7.24, Monday), Bloomberg reported that Tuesday's fixing was set 111 pips stronger than the average estimate in a Bloomberg survey — the largest premium since November.
Currency manipulation follows on from recent cuts to the Loan Prime Rate and the Medium Term Lending facility, both eased by an underwhelming 10bps.
The Kiwi's bid faded through the London morning, trading back through 0.6170 before mounting another attempt to break through 62 US cents during the early stages of US trade.
US bond yields spiked higher following the strong US data, ending the Kiwi's aspiration to re-establish a foothold above 0.62, again pulling back through 0.6170. The choppy price action is indicative of directional uncertainty, NZDUSD bulls unwilling to drive the pair higher whilst the bears lack conviction to push the Kiwi through 0.6116, the 50% Fibonacci retracement of the June rebound.
Looking to the day ahead, the headline data release is the monthly CPI read for Australia, expected to decline from 6.8% to 6.1%. Any deviation from the consensus estimate will spark lively price action for the antipodean cross.
Monday's high a couple of pips north of 0.9242 has met resistance at the 100-day moving average, NZDAUD pulling back through 0.9200 during Tuesday's local session before improving back to 0.9020.
A soft CPI result likely sends NZDAUD ripping through 0.9250 as the market adopts the view of an on-hold RBA decision at the 04 July meeting.
Central bank speakers will be the focus for offshore trade with Fed Chair Powell, ECB President Lagarde, BoJ Governor Ueda and the BoE Governor Bailey participating in a panel discussion at the ECB's annual forum in Sintra, Portugal.
Ueda aside, the central bank heads will likely maintain their hawkish messaging.
Regarding NZDUSD short-term directional bias, as we flagged yesterday an upside break of 0.62 or downside break of 0.6116 shifts the bias from neutral to bullish or bearish respectively.
We lean tentatively to the downside.
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Stuart Talman is Director of Sales at XE. You can contact him here.
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