Nasdaq logs best first half in over 40 years, gaining close to 40% on AI frenzy. Fed's preferred inflation measure, PCE softer-than expected but still elevated. Eurozone inflation also softer

By Stuart Talman, XE currency strategist

The last day of the month, quarter and half-year has fittingly delivered a strong performance for US equities given the Nasdaq logged it best first-half in over 40 years, as the dawn of the AI age catapults megacap tech stocks to eyewatering gains - Apple reaching a new all-time high and a market capitalisation of US$3 trillion!

Heading into 2023, not many (if any) would have predicted a close to 40% 6-month rally for the Nasdaq, nor a circa 16% 1H result for the broader S&P500. The base case called for a challenging year for US stocks as historically rapid Fed monetary tightening had the desired effect of cooling demand, sending the US economy into a widely anticipated recession.

Yet despite a regional banking crisis, sticky inflation remaining well above target, an underwhelming China re-opening, multiple geo-political issues and a willing Fed with more shots to fire, recession has not come, US equities continue to defy gravity.

One of the major storylines for the US economy over the past few weeks has been stronger-than-expected activity data mixed with mildly softer-than-expected inflation reads.

Friday's US session followed this theme, the Fed's preferred measure of inflation, core personal consumption expenditures (PCE) printing softer at 0.3% MoM and 4.6% YoY (vs 0.3% & 4.7%, expected). Peaking at 5.2% in September, core PCE has printed at either 4.6% or 4.7% through the first half of 2023. So, whilst price pressures have eased, they remain at uncomfortably elevated levels.

US bond yields and the dollar were firmer heading into the PCE release, giving back some of the week's gains immediately following. The mix of falling yields and a strong open for US stocks propelled risk sensitive currencies higher, lifting the New Zealand and Australian dollars to the top of the G10 leaderboard, the Kiwi logging an intraday gain of over 1% whilst its trans-Tasman peer gained around three-quarters-of-a-percent.

Looking vulnerable to move back below 60 US cents following Thursday's overnight sell-off, the Kiwi's rebound from a 3-week low at 0.6050 commenced during the Asian afternoon as China's manufacturing PMI printed in-line whilst the non-manufacturing (services and construction) headline index exceeded the consensus estimate.

Touching 61 US cents in the closing stages of local trade, NZDUSD eased back 20 pips through the London morning before catching a bid following the PCE release. Marking Friday's high a couple of pips through 0.6140, the Kiwi consolidated Friday's gains through the New York afternoon and into the close, ending the week in the 0.6130's, logging a marginal weekly loss.

Despite the strong end to the week, the Kiwi remains pressured against the dollar given the perception that the US economy is performing better than its developed nation peers, evidenced by the recent run of strong data, including upside beats for GDP, housing and manufacturing data this past week.

In turn, this has pushed the market to more closely align with the Fed's projected two additional rate hikes, thereby driving US treasury yields higher. The yield on the 2-year government bond, which is more sensitive to Fed policy relative to the benchmark 10-yr yield, extended higher closing in on 5%, Friday. Cycle and 16-year highs were marked in early March just shy of 5.10%, before plunging through 3.60% later in the month as US regional banking stress threatened to spillover, causing a more widespread global banking crisis.

Whilst US yields have marched higher through May and June, further upside may be limited as the bar is now set high for the Fed to deliver another hawkish surprise given the mature stage of the cycle. It would take a sustained run of strong jobs numbers and upside inflation beats (via CPI, PPI & PCE) for a terminal Fed funds rate north of 6% to be considered.

So, whilst the Kiwi may take another look below 60 US cents in the short-term, barring the re-emergence of pronounced market stress, we're unlikely to see a return to October's levels near 55 US cents.

Against its other major peers, the Kiwi gained around half-a-percent versus the CAD and JPY for the week and just shy of a quarter-of-a-percent against the AUD. NZDGBP logged a marginal weekly gain closing near 3+ year lows near 0.48.

The Kiwi declined -0.20%, week-on-week, against the EUR but did recover circa 1% off the week's low near 0.5550 to end the week back through 0.56. Eurozone core CPI released on Friday printed softer-than-expected (5.4% YoY vs 5.5% expected) but remains at an elevated level that requires likely ECB hikes at the July and September policy meetings.

A critical NZDEUR support zone is located between 0.5500/50, the pair forming prominent reversal lows in this region on four occasions dating back to March 2020. The 61.8% Fibonacci retracement of the March 2020 low to April 2022 high is located at 0.5554. A decisive break below here could open a path to test the 78.6% Fib level, located significantly lower at 0.5321.

Looking to the week ahead, the major event in a holiday (4th of July) shortened US week is non-farm payrolls (employment report) on Friday. Additional tier 1 US data points for the week include this evening's ISM manufacturing PMI and later in the week, the services PMI.

At a local level, we receive tier 2 releases, including building permits and business confidence.

The RBA's rate decision, tomorrow afternoon is the major regional event. Whilst market pricing heavily favours an on-hold decision, around half of polled economists call for a 25bps hike to 4.35%.

Other potential market movers include FOMC minutes, eurozone retail sales and ADP Employment change (US).

Will the Kiwi re-test 60 US cents this week?

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