Bond yields fall as US core PCE surprises to the downside, falling from 4.6% to 4.1%. US equities bounce back following Thursday's BoJ induced declines

By Stuart Talman, XE currency strategist

Softer than expected core personal consumption expenditure (PCE) and employment cost index (ECI) data provided the greenlight for the equity market bulls through Friday's north American session, driving the three major indices higher into the week's close.

Twenty-four hours earlier, risk sentiment negatively reversed on a BoJ leak, Nikkei's news service reporting the Japanese central bank would be announcing an adjustment its yield-curve control policy at Friday's monetary policy meeting (more on the BoJ to follow).

The leak sent US bond yields sharply higher, US equities firmly into the red.

Friday's session unwound the risk-off flows, the Nasdaq the noted outperformer, benefitting from softer treasury yields to log an intraday gain of +1.85%.

Core PCE, the Fed's preferred inflation gauge that strips out volatile food and energy prices increased at an annualise 4.1% (vs 4.2%, expected), its slowest pace since September 2021. Having peaked at 5.2% last September, the 4.1% result is an encouraging step-down given core PCE had printed at either 4.6% or 4.7% over the previous 6 months.

Whilst the Fed will cheer the downside surprise, the reality is PCE is still running at levels more than double the Fed's 2% target and could remain stubbornly elevated if the US labour market remains at historically tight levels. 

Commodity currencies failed to benefit from Friday's brighter risk mood, the New Zealand and Australian dollars joining the Japanese yen to occupy the bottom three rungs on the G10 ladder.

Friday's intraday loss nearing half-a-percent forced the Kiwi's weekly performance into negative territory, NZDUSD logging a marginal week-on-week decline of -0.08%. Despite the modest net move, Thursday's strong upside rejection accompanied by Friday's follow through selling maintains the upper hand for NZD sellers, price action continuing its downside surge from the 14 July high in the low 0.64's.

The Kiwi did improve into the week's close, finding support a pip or so above 0.6120 in the London morning before ranging between 0.6140 and 0.6180 during US trade.

Closing the week near 0.6150, the technicals suggest further downside beckons.

The sell off through the back end of the week pushed price action back below the 100 and 200-day moving averages, testing ascending trendline support that extends from 31 May and 29 June lows. The support aligns with the 38.2% Fibonacci retracement of the October to February rally, located at 0.6146.

Should NZD sellers drive the pair lower towards 61 US cents, we likely see a re-test of this range's midpoint, located at 0.6025. The year-to-date low at 0.5985 also likely to be re-tested.

Despite widespread calls for the US dollar's demise, the greenback has once again pulled itself back off the canvas to defy consensus opinion.

The popular view is that as the Fed nears the end of its tightening campaign, the dollar will enter a period of cyclical weakness.

However, recent strong macroeconomic data flow, solid earnings and increasing confidence in a soft landing have put a floor under the dollar. In addition, a run of unimpressive eurozone data has weighed on the euro, the largest currency by weight (~57%) in the dollar index.

Should US data continue to surprise to the upside, in particular the 2 x jobs and 2 x CPI reports that Fed Chair Powell repeatedly referenced during last week's FOMC presser, the dollar's rebound will continue through August.

The dollar index (DXY) closed the week at 101.70. This week's key upside level is 102.00, previously providing support on multiple occasions through June. US dollar bears would ideally want to see old support form new resistance, DXY failing to punch through 102.00.

A decisive ascent through 102.00 likely opens a path for the DXY to test the 100-day moving average, currently located near 102.50. Whilst this would not force the dollar bears into hibernation, it creates doubt regarding the expected lower path for the USD through the remainder of 2023.

Turning our attention to Friday's Bank of Japan monetary policy meeting, the BoJ maintained current policy settings - the main policy rate remaining at -0.1% whilst yield curve control will stay around 0% with a +/- band of 0.50%.

More flexibility was introduced, the BoJ announcing that under some circumstances the yield on the 10-year JGB could widen to 1%. The "maybe" tweak to YCC is regarded as another step towards the BoJ normalising monetary policy following December's widening of the YCC range.

Between the Nikkei article and the BoJ decision, it was a volatile final two days for the JPY, ranging between 138.00 to 141.00 against the dollar and 85.00 to 87.80 against the Kiwi.

Gaining over three-quarters of a percent, NZDJPY ended the week near 86.80, circa 3% off the 05 July high through 89.50, an eight year high.

Calls for a sustained run of JPY strength have proven premature as the BoJ continues to kick the can down the road and global bond yields remain near cycle highs.

Looking to the week ahead, the major event is Friday's US jobs report.

Market pricing assigns an 80/20 implied probability in favour of an on-hold decision at the Fed's 20 September FOMC meeting. A stronger-than-expected employment report would cause a hawkish repricing, increasing the odds of a 25bps hike, in turn propelling the dollar higher.

Regionally, the headline event is Tuesday's RBA interest rate decision. Market pricing assigns a 79% probability of an on-hold decision whilst 20 of 36 analysts via a recent Reuters poll, called for a 25bps hike.

It should prove to be a lively reaction given the finely balanced decision.

Locally the focus is on Wednesday's jobs report, the unemployment rate expected to tick up from 3.4% to 3.5%. 

It’s a busy start to the week with China PMIs and eurozone CPI dropping.

The Bank of England's interest rate decision is released Thursday evening, the BoE expected to step-down to a 25bps hike, bringing the bank rate to 5.25%.

ISM PMIs in the US also likely to induce volatility.

Given last week's swift rejection of the high near 0.6270 and soft weekly close, we favour further downside for the Kiwi, moving below 61 US cents should the US data flow continue to run hotter than expected.

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