NZD retreats from 4-mth highs following mammoth 2-day rally. Disinflation trade the order of play following downside CPI and PPI misses

By Stuart Talman, XE currency strategist

The disinflation trade was the major story of the past week, downside data misses for both consumer and producer prices delivering a pronounced risk rally as a chorus of market participants declared victory in the war on inflation.

Equity markets across the globe ripped higher, understandably the Nasdaq leading  the charge in the US, benefitting from a notable pullback in yields, gaining +3.32% for the week. The broader, S&P500 added +2.49% whilst the Dow advanced +2.29%.

The dollar index had its worst week since March 2020, shedding over 2% to slip below 100.00 for the first time since April 2022. Having fallen for six consecutive days, Friday brought a reprieve for the dollar, the sell-off halted on the back of hawkish Fed-speak and the preliminary reading for Uni of Michigan consumer confidence, reporting a step-up in 1 and 5 year inflation expectations. Consumer confidence reached its highest level in almost 2 years.

Gaining +2.60% for the week, the New Zealand dollar smashed through stout resistance near 62 US cents to mark Friday's high a couple of pips above 0.6410, the highest the pair has traded since early February. Shedding around a third-of-a-percent through Friday's sessions, NZDUSD ended the week near 0.6370.

A middling performer on the G10 leaderboard, the Kiwi was outpaced by some distance by the Norwegian Krone and Swedish Krona logging staggering week-on-week gains of close to 6%. The Scandies had been the two hardest hit amongst the G10 on the hard landing narrative.

Inflation deceleration against the backdrop of a resilient and mostly robust US economy emboldens the no landing/soft landing pundits, crowing I told you so.

Whilst the odds of a hard landing have significantly diminished this year, it's far too premature to declare that recession will be dodged.

It's also too premature to declare we're about to enter a period of cyclical USD weakness ... although there is a strong argument that supports further USD downside through 2H.

Should CPI and other key inflation reads continue to trend lower over the next couple of months, the Fed's widely expected 25bps hike on 26 July may be a case of one-and-done.

Provided global the macroeconomic data flow and corporate earnings modestly decline against the backdrop of an orderly cooling of global growth, risk sentiment should lean positive, providing a constructive environment for global equities and pro-cyclical currencies, including the New Zealand and Australian dollars to head higher.

Although, avoiding a recession may deliver the one outcome most feared - a re-acceleration of inflation .. this being one counterargument to the cyclical USD weakness narrative.

The other argument is financial market stress, or a full-blown crisis caused by a credit event arising in a troubled sector such as corporate real-estate.

 In this scenario, the dollar's safe haven status attracts capital inflows.

The Kiwi also logged a weekly gain in excess of 2% against the CAD, despite a 25bps hike from the Bank of Canada.

Against the GBP, the Kiwi climbed just over half-a-percent, again attempting to establish a foothold above 3+ year lows marked in the 0.4780's. The UK is the undesirable inflation leader within the G10. Whilst inflation is expected to materially decline in the months ahead, the past week delivered another upside wage inflation surprise, likely another 50bps hike from the BoE in early August.

A noted performer last week was the JPY, rallying on increasing speculation the Bank of Japan will further relax its yield-curve-control policy at its next monetary policy meeting, held on 28 July. The JPY also benefitted from US treasury yield's sharp reversal.

The Kiwi logged a marginal weekly gain versus the JPY, benefitting from the market's brighter mood through the back half of the week. Ascending to 8-year highs near 89.70 a couple of weeks back, NZDJPY ended last week near 88.40. Should we receive more signals of a BoJ policy tweak in the lead up the upcoming BoJ meeting, expect further downside for the pair.

Against its trans-Tasman peer, the Kiwi extended higher through 0.9300. Despite the RBNZ's first on-hold decision following 12 consecutive hikes, NZDAUD climbed for a fourth consecutive week, the Aussie struggling amidst poor China growth sentiment and the view the RBA may be done hiking.

Phillip Lowe gave one of his last speeches as RBA Governor this past week, the Australian Treasurer, Jim Chalmers announcing long standing deputy governor, Michelle Bullock as Australia's first female central bank head. Bullock will take over in September and may well take a tighter policy stance should inflation data fail to materially recede over the next two months.

Looking to the week ahead, it’s a busy start with a slew of activity data for China's economy released today. GDP, industrial production and retail sales follow a run of underwhelming data releases. The world's second largest economy is expected to grow at an annualised pace of 0.5% for the June quarter, slowing from 2.2% through 1Q.

It’s a quiet week for US data releases, retail sales the sole tier 1 release. Second quarter earnings season kicked off with the big banks on Friday. This week, the likes of Goldman Sachs, Morgan Stanley and Bank of America will be the headline reports with focus also given to the smaller, regional banks. Other big names reporting this week include Tesla, IBM and Netflix.

Corporate earning remain robust, balance sheets healthy and flush with cash ... another dynamic that prevents recession.

Locally, the headline event is second quarter CPI, expected to drop from 6.7% to 5.9%. Inflation peaked at 7.3% during the June quarter, last year. A sub-6% figure validates the RBNZ's decision to pause, adding further weight to the argument that peak OCR has been reached.

The UK also releases CPI, the monthly core reading expected to remain at the cycle peak of 7.1%.

Across the Tasman, June jobs numbers are released, Thursday, the Australian economy expected to add 17K new jobs whilst the unemployment rate remains steady at 3.6%.

Having rocketed higher by over 3% through the second half of last week, can the Kiwi's run continue to challenge the year to date high a couple of pips shy of 0.6538?

Technical indicators are extremely stretched suggesting either a pullback or consolidative, range bound trade is the order of play for the week ahead.

Importers with near term hedging decisions, don’t get trapped by sitting on your hands, hanging out for an expected move through 65 US cents. We'd likely need to see some positive China news flow, reporting fresh fiscal stimulus for NZDUSD to find a foothold above 0.65.

Our near-term topside level to monitor to start the week - 0.6420 which represents the 78.6% Fibonacci retracement of the February to May sell-off. Friday's high came within ~8 pips. A break above likely opens a path to test 0.65.

On the downside, the first Fib level to monitor is the 23.6% retracement of the rebound of the 31 May low, located at 0.6311.

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