By Stuart Talman, XE currency strategist
During yesterday's FOMC press conference, Chair Powell reiterated the Fed's data dependant approach in response to journalists questions, many of which attempted to extract a response from Powell that would signal if the Fed funds target rate would again be raised at the next FOMC meeting on 20 September.
Powell was clear - the two jobs reports, the two CPI reports and other key data releases over the next 8 weeks would determine the outcome…..the Fed, unlike last year, is not on a set course to raise rates.
The market interpreted this as somewhat dovish, US treasury yields and the dollar fell, US equites recovered pre-FOMC losses to close mixed (S&P 500 & Nasdaq down, Dow up).
Powell refraining from kicking back against the recent easing in financial conditions (US equities' staggering year-to-date rally) was regarded as the missing piece required to deliver an uber-hawkish message.
Twenty four hours later, stronger than expected US data has reversed the FOMC-induced fall in bond yields, the dollar has rebounded and US stocks continue to push higher, although sellers have emerged during the second half of US trade.
Durable goods orders, pending home sales, weekly jobless claims and the preliminary reading of 2Q GDP have all printed hotter than expected, fuelling the soft landing narrative.
How can the US economy possibly be headed for a recession?
Various activity indicators continue to report economic resiliency despite yesterday's 11th hike of the cycle bringing the cumulative amount of Fed monetary tightening to 525 bps.
Expanding at an annualised rate of 2.4% (vs 1.8%, expected), up from 2% the prior quarter, the world's largest economy almost appears immune to one of the most historically aggressive tightening cycles.
Weekly initial jobless claims followed last week's outcome, notably undershooting the consensus estimate (221K vs 235K), confirming the number of Americans filing for unemployment support fell to a 5-month low. Continuing claims also plunged to the lowest reading since January, indicative of jobseekers that have re-entered the workforce with relative ease.
So, back to our question: how can the US economy be headed for a recession?
Answer: because the Fed has no choice but to engineer one.
Yes, inflation in the US has pulled back a notable distance from cycle highs (headline: 9.1% to 3.0%; core: 6.6% to 4.8%), but it remains well above the Fed's 2% target (note: Fed focuses on core, not headline inflation).
The historical record informs that if the economy is not sufficiently cooled (recession), the inflation wildfire re-ignites, requiring even more aggressive monetary tightening.
Annualised economic growth at 2.4%, monthly jobs growth north of 200K, an unemployment rate at 3.6%, household balance sheets with record levels of cash, a resilient housing market, US stocks setting up to re-test all-time highs…..this is not sufficient cooling.
The Fed may be required to hike the Fed funds target rate through 6%, or at the very least maintain a terminal rate just below 6% for a prolonged period.
Outcomes that the market currently dismisses.
Current market pricing implies a terminal rate at the current target rate (5.25% - 5.50%) whilst multiple rate cuts are expected through 2024.
If the market is proven wrong, US recession is an inevitability.
The widely predicted demise of the dollar, delayed.
The New Zealand dollar was a middling performer amongst the G10 cohort, shedding around a half-of-a-percent to slip back below 62 US cents. Whilst the net loss taken on its own does not suggest the NZD bears have the upper hand, taking the price action into consideration does.
Earlier in the day, the Kiwi ripped higher climbing from near 0.6200 to mark an intraday high a few pips through 0.6270 during the early stages of the Asian afternoon.
Price action consolidated through European trade, suggesting NZD bulls would further lift NZDUSD to mount an important test of resistance at 63 US cents.
However, the release of the strong US data has extinguished the bulls efforts, NZDUSD rapidly reversing course marking overnight lows through 0.6180.
Should selling continue through Friday's sessions, pushing the Kiwi back below the 100 and 200-day moving averages and ascending trendline support resulting in a week-on-week loss, we suspect an important test of 0.61 support is on the cards for next week.
Heading across the Atlantic, the major news story was the ECB's interest rate decision, like the Fed delivering the widely expected outcome of a 25bps hike. The key takeaways:
- ECB hikes by 25bps lifting deposit rate to 3.75%, financing rate to 4.25%
- Statement accommodative to further rate hikes
- Lagarde refrains from forward guidance
Having pre-announced Thursday's hike back at the June meeting it came as a surprise to absolutely no one that the ECB hiked its three policy rates by 25bps.
Given the run of recent weaker-than-expected activity (PMIs, IFO, bank loans) data, market participants were focused on the tone of the statement and President Lagarde's presser….would the ECB signal more tightening ahead or flag the job is almost done amidst the softening data flow?
The statement maintained the ECB's tightening bias, commenting;
The developments since the last meeting support the expectation that inflation will drop further over the remainder of the year but will stay above target for an extended period. While some measures show signs of easing, underlying inflation remains high overall.
... implying that more hike are to come.
However, Lagarde struck a more cautious tone, unlike the June meeting, not willing to pre-commit to another 25bps hike at the 14 September meeting. Lagarde highlighted the weaker eurozone growth outlook but also emphasised that inflation was expected to remain above target for an extended period.
On multiple occasions, Lagarde commented that anything was on the table for the September meeting.
The EUR was a noted laggard, shedding over one-percent against the dollar whilst the Kiwi advanced around half-a-percent. Climbing through 0.5650, NZDEUR reached its highest level in three weeks, adding further weight to the case that the late June and July lows have formed a prominent double bottom.
The midpoint of the May to July sell-off and the 100-day moving average are both located near 0.5680. Price action finding a foothold above here provides further confirmation the NZDEUR cycle low will remain in place for the short to medium term.
Looking to the day ahead, the headline event on the economic calendar is the Bank of Japan's monetary policy meeting, now widely expected to maintain current policy settings given recent comments from both BoJ and MoF officials.
Also in focus, core personal consumption expenditure for the US economy, the Fed's preferred inflation gauge expected to fall from 4.6% to 4.2%. A downside miss would reverse some of Thursday's US dollar strength.
Can the Kiwi reclaim territory north of 62 US cents or will the bears maintain control into the week's close, setting up a test of sub-0.61 levels, next week?
Given yesterday's reversal, we favour further NZDUSD downside.
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Stuart Talman is Director of Sales at XE. You can contact him here.
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