By Stuart Talman, XE currency strategist
Following the release of the September US CPI report, bond yield and the dollar have ratcheted higher whilst the three major US equity indexes retreat through the New York afternoon. Pro-cyclical currencies are the notable laggards - the New Zealand and Australian dollars occupying the bottom two positions on the G10 leaderboard, the Kiwi down over one-and-a-quarter-of-a-percent whilst the Aussie’s slide reaches 1.50%.
Given the reaction (the yield on the US 10-year climbed from below 4.55% through 4.66%), you would have expected CPI to have printed significantly higher than consensus estimates.
Not the case.
Headline inflation for September came in at 0.4% month-on-month, leading to annualised inflation remaining steady at 3.7%. It was a modest upside beat, surpassing the expected outcome of 3.6%. At 0.3% MoM and 4.1%, annualised, core inflation printed in-line with consensus.
Prior to the CPI release, market pricing assigned a 10% implied probability of a 25bps hike at the 01 November FOMC meeting and 30% assigned to a hike at either the November or December meetings. Just shy of 80bps of cuts are priced in, next year, with the timing of the first cut in June/July.
The marginal CPI beat is not enough to move the needle - the Fed will maintain a 5.25% - 5.50% target rate through November and most likely into the new year barring more significant upside surprises in October's or November's CPI reports and jobs data.
What is clear from the bond market's reaction is the lingering concern that, whilst closer to the Fed's 2% target, sticky inflation will remain stubbornly high, failing to track lower from current levels.
Having peaked at 6.6% twelve months ago, core inflation running above 4% is still double the Fed's target and will likely stay elevated for as long as the US labour market remains tight and households sustain non-recessionary levels of spending.
Another takeaway from Thursday's price action - it’s far too premature to write off the US dollar.
Having fallen for five consecutive days following an 11-week rally, the dollar index (DXY) pulled back from above 107.34 to within a few pips of 105.50. The CPI induced spike has propelled the DXY from 105.65 through 106.50.
Whilst the Fed may be done hiking, the focus has shifted from how high the Fed funds rate will reach to how long the peak rate will remain in place.
The Fed's higher for longer mantra, in addition to a deluge of US government debt issuance have been the two primary culprits in sending US treasury yields to their highest levels since 2007. A cohort of bond market commentators believe US yields have further to run, citing sticky inflation and the Bank of Japan's inevitable abandonment of its yield curve control (YCC) policy as two factors that will support a further extension higher.
Note: Japan is the largest foreign holder of US government debt.
When the BoJ ceases YCC and lifts the policy rate back into positive territory, yields on Japanese government bonds will soar, catalysing a wave of capital flows from US to Japanese debt. Falling demand for US bonds will suppress bond prices, thereby lifting yields.
Shifting the focus back to currencies, the New Zealand dollar ultimately failed to break through the 0.6000/50 resistance zone we flagged as a major hurdle to overcome in order to shift the short-term bias from neutral to bullish.
Range trading between 0.6000 and 0.6030 through Asian and European trade, the Kiwi has shed circa 80 pips following the CPI release, falling through 0.5930. The aggressive rejection of 0.6050 pushes NZDUSD back below the midpoint of the 0.5860 - 06050 range that has prevailed over the past 7 weeks.
Attention now shifts to a 0.5880 0 0.5900 support zone.
A break below likely opens a path to re-test the year-to-date low a pip or so below 0.5860.
In other news from Thursday, the release of ECB minutes from the September meeting have confirmed that it may be premature to declare an end to the eurozone tightening cycle given governing council members acknowledged that inflation risk remains to the upside.
The ECB's September hike was viewed as a dovish outcome as the market subscribed to the view that at 4.00%, the deposit rate had reached its cycle peak.
Rebounding over 5% from its 21 August and three years low near 0.5420, NZDEUR traded through 0.5700 at Tuesday's highs. Two days of selling has driven the pair down to the 0.5620's and notably, a rejection of the 200-day moving average, located near 0.57.
A December rate hike remains on the table for the ECB. The eurozone central bank could opt for a year-end hike should inflation readings over the next two months fail to track lower.
Looking to the day ahead, regionally, CPI and trade data for China will be the focus.
A quiet offshore calendar presents Uni of Michigan consumer sentiment whilst multiple central bank speakers from the Fed, ECB and BoE will capture attention.
Yesterday we asked the question: can the Kiwi breakout above 0.6050 or will a CPI beat see NZD bears wrestle back control?
We'll be watching Friday's price action to determine whether the knee-jerk reaction to the US CPI report was overdone, or the dollar's dominance is set to continue as US treasury yields resume their relentless ascent.
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Stuart Talman is Director of Sales at XE. You can contact him here.
4 Comments
The US dollar isn't done at all. In fact, both dollar and yields will rise in tandem.
The argument is this:
Yields rise because of excessive issuance and "higher for longer"
High quantity of bonds get absorbed by markets
Dollar liquidity is sucked (to buy these bonds)
Dollar rises
Dollar denominated debt gets harder to repay
Dollar denominated bonds need to be sold
Yields rise again...
Of course, this is theoretical. It will get tested in due course, but I expect dollar and yields to rise in tandem for sure.
When the BoJ ceases YCC and lifts the policy rate back into positive territory, yields on Japanese government bonds will soar, catalysing a wave of capital flows from US to Japanese debt.
I've floated this narrative at the water cooler but no response as to how this impacts Nu Zillun.
Japanese pension funds are poised to sell some of their treasuries and other USD denominated bonds, yes. This will raise US treasury yields further. This will raise US Dollar, causing NZD to go lower.
There may be some other effects too, but this is what is see happening in relatively short order.
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