Choppy, directionless trade continued, downside bias retained. US bond yields higher for the week following more strong macro data

By Stuart Talman, XE currency strategist

Friday delivered an uneventful end to the week, choppy, directionless conditions extending through a third day in the absence of any market moving events. US equity markets squeezed out marginal gains and ended the week lower, the S&P500 shedding -1.29% whilst the Nasdaq declined -1.36% for the week.

The dollar continues its relentless rally, the DXY advancing +0.82% for the week to extend its run of week-on-week gains through an 8th week. The greenback continues to benefit from the US economic exceptionalism narrative, evidenced by a sustained run of stronger-than-expected macroeconomic data.

In a relatively quiet week, declining weekly jobless claims and an upside beat for the ISM Services PMI added to the suite of indicators that record a US economy that continues to perform well under the weight of 500bps of Fed tightening. This is in stark contrast to the eurozone and China economies which continue to underwhelm, the former heading for recession whilst the world's second largest economy undershoots growth expectations amidst intensifying concerns regarding the deteriorating property market.

The US data flow continues to support US bond yields. Following a pullback from 15+ year highs the week prior, yields resumed their upside bias, the benchmark 10-year ending the week through 4.26%. Ascending through 4.36% on 22 August, the yield reached its highest level since late 2007 as the bond market subscribes to the view the Fed will hold the target rate at its peak for a prolonged period.

In turn, the dollar continues to outperform its major peers.

Declining just shy of one percent for the week, the New Zealand dollar marked a fresh year-to-date low a pip or so below 0.5860 following Tuesday's pronounced sell-off. The remainder of the week was monotonous, NZDUSD stabilising to range between 0.5860 and Friday’s high, a couple of pips shy of 0.5920.

The Kiwi was unable to maintain a foothold above 59 US cents, retreating throughout US trade to end the week near 0.5880.

The Kiwi also struggled against its other major peers, falling -0.69% versus the CAD, -0.31% against EUR whilst net weekly moves against the AUD, JPY and GBP were negligible.

Following pronounced directional moves through July and August, currencies have chopped around through the first week of September, awaiting their next directional impulse as the Fed and other major central banks enter the concluding stages of their respective tightening cycles and the long and varied lag effects of monetary policy materialise.

Heading into the final quarter for 2023, the market's attention will shift from central bank policy to the macroeconomic data flow to assess the growth outlook and which economies will buckle under the weight of the most aggressive tightening cycle in over 40 years.

In the US, a few prominent analysts from leading US banks assign a 15%-20% probability the US economy falls into recession. Earlier in the year, odds comfortably exceeded 50%.

The US dollar is likely to continue to outperform, or at very least, consolidate the past 8 week's gains through the remainder of the year should the US growth outlook remain relatively favourable.

Looking to the week ahead, there are two major events that will consume the market's attention.

Firstly, US CPI is released during Wednesday's overnight session.  Higher energy prices are expected to lift headline CPI from a month-on-month reading of 0.2% in July to 0.5% in August. The core rate of inflation is projected to match July's MoM reading of 0.2%.

Whilst the Fed is widely expected to maintain a 5.25%-5.50% target rate at the 20 September FOMC meeting, a hot CPI report would raise the likelihood of a November hike. Current market pricing assigns a ~44% implied probability of a 25bps hike in November, up from around 30% a month ago.

Secondly, the ECB monetary policy meeting is the week's other major event.  In a recent Reuters poll 39 of 69 analysts called for the ECB to maintain current policy settings with the balance favouring a 25bps hike. Market pricing favours the pause.

Recent activity data for the eurozone economy has mostly surprised to the downside, yet inflation runs well above target, still above 5%. Some ECB governing council members clearly favour one more hike whilst others favour a pause to further assess the incoming macroeconomic data flow.

A live ECB meeting will likely induce pronounced moves for EURUSD and the EUR crosses.

Additional market movers include UK and Aussie jobs reports, US retail sales and producer prices and China activity data.

The expected path for the Kiwi this week?

Given the soft weekly close within ~20pips of year-to-date lows, the path of least resistance continues to be to the downside. Surging crude oil prices could prove disastrous for the major central bank's attempts to further rein in inflation.

The overt risk to US equities and other risk sensitive assets this week - a hot headline CPI number catalysing a deleveraging wave…..NZDUSD could trade sub-0.58.

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