Softer China CPI and PPI adds to the run of weak macroeconomic data. US bond yields extend pullback from last week's highs, weigh on the US dollar

By Stuart Talman, XE currency strategist

Light news flow and an economic calendar absent any market moving events has ensured a quiet start to the new week. Markets trade with a cautious undercurrent ahead of Wednesday evening's headline event for the week - the June CPI report for the US economy.

One of the major storylines over the past few weeks has been renewed Fed hawkishness, Jerome Powell and his FOMC colleagues have made it clear: the US economy is sustaining a level of activity that will not return inflation to the Fed's 2% target.

A couple of weeks back, the Fed's preferred inflation gauge, personal consumption expenditures printed north of 4%.

This week, core inflation is expected to further ease (from 5.3%), but still deliver a figure at 5.0% (expected) or above should consumer prices surprise to the upside. '

Much has been made about the encouraging decline in headline inflation (includes volatile energy and food prices) from its peak above 9% in mid-2022, to an expected reading closer to 3%, this week.

However, the Fed is not focused on the headline print, rather its core services inflation ex-shelter, that includes components such as medical services, insurance and education, that continues to cause concern. Unlike goods inflation, services inflation is stickier and a far greater risk in fuelling the dreaded wage-price spiral.

A recent run of stronger than expected macroeconomic data including last week's ISM Services PMI and ADP Employment change data points has driven US bond yields higher. Last week, the yield on the Fed policy sensitive 2-year bond climbed back through 5%, marking a fresh year-to-date high. The yield on the benchmark 10-year also reaching a new 2023 high, through 4.09%.

In turn, this has supported a firmer US dollar.

Many an analyst has favoured a softer dollar through the second half of 2023 given expectations the Fed would have ended its aggressive tightening cycle by now. However, this view has proven premature, given one, maybe two more hikes will be delivered during the mature stage of the cycle.

Dollar strength was tempered through the final sessions of last week following the release of the Bureau of Labor Statistics (BLS) non-farm payrolls, Friday. Surprising to the downside (209K vs 230K, expected), NFP did not align with the white-hot ADP number…..which should come as no surprise given a long track record of ADP/NFP deviation.

Whilst Friday's jobs report was by no means soft - 209K is still a robust number, in addition the jobless rate ticked down to 3.6% and wage inflation beat expectations; bond yields pulled back from upswing highs, producing a soft weekly close for the dollar.

Commencing the new week near 62 US cents, the New Zealand dollar has logged a marginal gain through Monday, falling through Asian and European trade before recovering through the US session.

One of the Kiwi's current headwinds is poor sentiment regarding China's sluggish economic performance, the world's second largest economy failing to deliver the expected rebound following the abandonment of zero-Covid in late 2022.

The recent macroeconomic data flow out of China has underwhelmed.

Consumer and producer prices, released yesterday, added to the soft run.

Consumer prices for June unexpectedly flattened (0.0% vs 0.2%, expected), delivering the lowest MoM reading since February 2021. Worryingly, producer prices dropped 5.4% YoY (vs a drop of 5.0%, expected).  It was the ninth consecutive month of producer deflation and the fastest fall since December 2015 amid weakening demand and moderating commodity prices. 

The CPI and PPI results caused the CNY to weaken, in turn weighing on the Kiwi and Aussie dollars, NZDUSD offered through 0.6180 during the Asian afternoon, before further selling pushed the pair to an intraday low a few pips through 0.6170.

Speculation is growing that Chinese authorities will announce a significant economic stimulus program.

The Kiwi's fortunes have reversed through US trade, as treasury yields extend Friday's pullback. Rebounding over three-quarters-of-a-percent from intraday lows to highs, NZDUSD has reclaimed territory north of 62 US cents to mark an early morning high a couple of pips shy of 0.6220.

A critical resistance zone has formed in the 0.6200/20 region over the past five trading days. Whilst price action threatens to break out above here, the NZD bulls likely won't commit unless an in-line or softer-than-expected CPI report is received in the early hours of Thursday morning.

Tomorrow's RBNZ interest rate decision is unlikely to deliver a hawkish outcome to support a higher NZD. Widely expected to keep the OCR on hold at 5.50%, its shaping up as one of the more uneventful RBNZ meetings in recent times.

Looking to the day ahead, the headline event is the UK employment report.

The focus will be on the average earnings data point which has been running hot. Last month's regular pay number (excluding bonuses) rose at the fastest pace since the pandemic. Should wage inflation continue to surprise to the upside, the Bank of England is left with little choice but to hike the bank rate through 6%.

Last month the BoE lifted the policy rate by 50bps to 5.00%.

Another hot wages number could drive NZDGBP back below 0.4800 and fresh 3-year lows.

UK Jobs numbers aside, it’s a mundane economic calendar for Tuesday.

We suspect markets will slip into wait-and-see mode ahead of US CPI…..the Kiwi to trade in a similar intraday range to Monday's, price action expected to be contained between 0.6160 and 0.6220.

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