US yields rebound inducing broad based USD strength. USD on track for 8th week of gains - longest winning streak in 10+ years

By Stuart Talman, XE currency strategist

Reopening following the Labor Day long weekend, US markets have carried through Friday's intraday directional moves, notably US treasury yields are sharply higher inducing broad based USD strength.

With a strong start to the week, the dollar index (DXY) looks well placed to log an eighth consecutive week of gains, its longest winning streak in over a decade.  A relative measure of the US dollar against a basket of six major currencies, the DXY approaches the top of a 10-month range, ascending within reaching distance of 105.00 through overnight trade.

A decisive topside breakout through 105.00 as US bond yields continue to head north would fray the market's nerves, likely leading to a pronounced downside correction for US equities.

US economic exceptionalism in addition to China and eurozone growth concerns have been the catalysts for the dollar's two-month rally which now appears to be overstretched against some currencies.

Given their sensitivity to the Chinese economy, the New Zealand and Australian dollars have been two of the worst performing currencies amongst the G10 cohort during this period.

From its 14 July peak above 64 US cents, the Kiwi has shed over 8%, lurching to a fresh year-to-date low a pip or so below 0.5860 during the New York morning.

A bruising day for the antipodeans has seen the Kiwi shed around one percent whilst the Aussie claims the bottom rung on the G10 ladder, falling around one-and-a-quarter percent.

Weaker-than-expected services PMI data out of China and an on-hold interest rate decision from the Reserve Bank of Australia, the two catalysts for the Kiwi's and Aussie's woes.

Monday's Asia-session risk on vibes have evaporated following another macroeconomic data point highlighting the sluggish performance of the world's second largest economy. The Caixin PMIs survey purchasing managers from privately owned small and medium sized enterprises, whilst the official NBS PMI is focused on larger, state-owned businesses. The Caixin PMIs are therefore regarded as covering a broader sample of manufacturing and services activity throughout China's economy.

Falling from 54.1 in July to 51.8 (vs 53.6, expected), the Caixin services PMI reported the softest pace of service sector growth since the start of the year as new order growth, export sales and prices all declined.

As China's property market continues to struggle consumer sentiment has significantly deteriorated prompting households to increase savings given a lack of optimism regarding the economic outlook.

To date, the Chinese authorities have announced a series of underwhelming policy measures that are yet to restore confidence.

The China data initiated a wave of NZD selling through the Asian afternoon, driving NZDUSD through 0.5930 support ahead of the RBA's interest rate decision.

As widely expected, (market pricing assigned a ~90% probability) the RBA kept the cash rate on hold, the key takeaways:

• RBA holds, maintains cash rate at 4.10%
• RBA maintains tightening bias
• RBA acknowledges uncertain China growth outlook

It was an unremarkable end to RBA Governor Lowe's seven-year stint, both the outright decision and the accompanying statement bereft of any surprises.

Whilst the RBA left the door open for additional hikes via some further tightening of monetary policy may be required to ensure that inflation returns to target in a reasonable timeframe, a balanced statement acknowledged the impact of higher borrowing costs: The Australian economy is experiencing a period of below-trend growth and this is expected to continue for a while…….The outlook for household consumption also remains uncertain, with many households experiencing a painful squeeze on their finances.

In addition, the RBA flagged the deteriorating China outlook, commenting (anew): And globally, there is increased uncertainty around the outlook for the Chinese economy due to ongoing stresses in the property market.

A dovish leaning statement that follows recent downside misses in CPI and jobs data further raises the bar for a late-cycle hike…...the consensus forecast calls for the current 4.10% cash rate as the cycle peak.

The Australian dollar was the sole major currency the Kiwi outperformed through Tuesday, NZDAUD bid from the 0.9190's prior to the RBA's decision/statement, to within a few pips of 0.9230 at the day's apex.  The antipodean cross remains firmly entrenched within a 0.9180 - 0.9230 range that has prevailed over the past two weeks.

Heading into the European session, the Kiwi's descent quickened, NZDUSD piercing through 59 US cents with ease before finding support a pip or so below 0.5960 during the New York morning.

Losses were modestly pared through the second half of US trade…...the Kiwi commences Wednesday's local session in the 0.5880's.

Looking to the day ahead, GDP across the Tasman, eurozone retail sales and the ISM Services PMI for the world's largest economy are the tier 1 data releases. The Bank of Canada follows the RBA, also widely expected to keep the main policy rate on hold (at 5%).

You could argue that Tuesday's sell-off overshot the mark.

Weak China macro data is not a new development whilst the RBA was universally expected to hold. Yes, US bond yields have logged back-to-back days of strong gains, however the 10-yr's rebound through 4.25% is still below the 22 August 16 year high near 4.36%.

We therefore haven’t received any new developments that provide impetus for the New Zealand dollar to extend further below 10-month lows.

A potentially softer-than-expected (52.6) ISM Services PMI looms as the obvious catalyst to cool the dollar's jets, propelling the Kiwi up through 59 US cents. Alternatively, should the run of strong US macro data continue this evening and beyond, NZDUSD could test the October 2022 low near 55 US cents before the month is done.

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