Fed officials out in force this week to remind that inflation is still too high. RBA delivers consensus 25bps hike to 4.35%; AUD falls in response

By Stuart Talman, XE currency strategist

The question for the market participants this week: were last week's pronounced directional moves an overreaction to soft US data points and a noncommittal (to additional tightening) Fed?

This week's lengthy lineup of Fed speakers may temper the view that the Fed is done.

Next week's US CPI report for October may provide the required evidence to definitively answer this question.

Referencing the dollar's start to this week, a small and uneventful range day through Monday has been followed by notable dollar strength through Tuesday, although some of the USD's gains have been unwound through US trade as longer-date yields head south through the New York morning.

The New Zealand dollar has failed to extend meaningfully beyond 60 US cents, falling over half-a-percent through Tuesday's sessions to mark intraday lows a pip or so above 0.5910.

In Monday's update we flagged a couple of key upside hurdles for the Kiwi to clear to continue last week's impressive rebound, the first being the 100-day moving average, currently located near 0.6020, the second being the 11 October swing high at 0.6056.

Price action through the first half of this week suggests these levels will remain unchallenged in the short term as next week's US CPI report looms as the next obvious directional catalyst.

In the wake of last week's FOMC meeting and given it’s a quiet macro data week, Fed speakers will be in the spotlight as they share their latest thoughts on the inflation, the US economy and the near-tern path for the Fed funds target rate.

Fed presidents Austan Goolsbee (Chicago) and Neel Kashkari (Minneapolis), both FOMC voters were interviewed overnight. Their message was clear: inflation remains too high; the Fed's job is not yet done. Whilst not explicitly committing to resuming the tightening cycle, both officials commented that economic activity and the labour market remain robust and resilient, there is limited evidence the world's largest economy is weakening.

Their views align with Powell's comments in last week's FOMC presser, the Fed chair commenting that he and his FOMC colleagues were not even thinking about cuts, questioning whether the policy rate had reached a sufficiently restrictive level.

Powell also stressed that the recent tightening in financial conditions, induced via the eye-watering rally in longer dated treasury yields and the ~10% pullback in US equity markets from year-to-date highs will only factor into the Fed's decision making to not resume the tightening cycle if the tightness is sustained.

The S&P500, Nasdaq and Dow are on track to log a seventh consecutive day of gains, their longest winning streaks in around 12 months.

Falling through 4.60% during Tuesday's US session, the yield on the benchmark 10-year note is over 40bps off its 23 October, 16-year high.

Most of the tightening in financial conditions that evolved through September and October has been unwound in a little over a week.

Next week's CPI data may prove pivotal in confirming who is right.

A hot CPI report (an annualised core reading above 4.2%) - the market will reprice to align with the Fed's view that additional tightening is required to return inflation to the Fed's 2% target.

US yields and the dollar resume their ascent.

A soft CPI report (core 4% or lower) - the Fed will more closely aligns with the market's view that at 5.25%-5.50%, the target rate reached its peak back in July.

One central bank that is not done: the Reserve Bank of Australia, delivering a consensus 25bps hike on Melbourne Cup Day. The key takeaways:

• RBA hikes by 25bps, lifting the cash rate to 4.35%
• RBA cites slow progress in returning inflation to target band
• Inflation forecast for 2024 revised higher

Following four consecutive on-hold decisions, Michelle Bullock has delivered her first rate hike as the new RBA Governor, eager to stamp her inflation fighting credentials early in her 7 year tenure.

Whilst those in the forecasting community heavily favoured the quarter point hike following on from a stronger-than-expected 3Q CPI report, market pricing was more evenly balanced assigning a 60/40 split in favour of a hike.

In its accompanying statement the RBA board commented:

Inflation in Australia has passed its peak but is still too high and is proving more persistent than expected a few months ago. The latest reading on CPI inflation indicates that while goods price inflation has eased further, the prices of many services are continuing to rise briskly. While the central forecast is for CPI inflation to continue to decline, progress looks to be slower than earlier expected.

It's clear from both the outright decision and the statement, the RBA like the Fed and other major central banks is concerned that inflation is not tracking as expected, specifically disinflation forces are not as strong and sustained as forecasted meaning the return to the RBA's 2%-3% target band is likely to occur sometime later in 2025.

In its August forecasts, the RBA predicted trimmed mean inflation would return to 3.3% at the end of 2024. Per yesterday's statement: CPI inflation is now expected to be around 3½ per cent by the end of 2024 and at the top of the target range of 2 to 3 per cent by the end of 2025.

The question now: is the RBA done, or will the cash rate approach 5% in early 2024?

The RBA statement fell short of providing clear forward guidance, instead concluding with: Whether further tightening of monetary policy is required to ensure that inflation returns to target in a reasonable timeframe will depend upon the data and the evolving assessment of risks.

Current pricing in 30-day interbank cash rate futures price in less than an additional 25bps hike to the current cycle.

The next monthly CPI print for the Australian economy is released on 29 October. Another reading above 5%, accompanied by solid jobs numbers could induce a year-end hike at the 05 December meeting….or more likely a February hike to commence 2024.

The Australian dollar initially rose before lurching lower in what appears to be a sell the fact response given the statement was absent any clear dovish references. Spiking a pip or so through 65 US cents, AUDUSD fell close to 1% throughout Tuesday's sessions, falling to within a few pips of 0.64 before paring losses to start Wednesday's local session near 0.6430.

The Kiwi has gained around half-a-percent against the Aussie, NZDAUD climbing from the 0.9180's prior to the decision to mar intraday highs around 0.9240.  Downside risk remains for the antipodean cross given the RBA's relative hawkishness versus the RBNZ in addition to better macroeconomic dynamics across the Tasman.

Looking to the day ahead, the RBNZ release inflation expectations for the December quarter whilst German CPI, eurozone retail sales and more Fed speak present as volatility inducing events.  Fed Chair Powell will be speaking in the early hours of Thursday morning.

Early in the week the focus was on upside hurdles for NZDUSD to test…...now, the attention shifts back to downside support and Fibonacci retracements.

The 38.2% Fib retracement of the rebound from October lows is located at 0.5915. Tuesday's lows were marked near 0.5910. Back in mid-October, 0.5930 formed resistance, forcing the pair to initiate a fresh downswing to the cycle low a few pips above 0.5770.

We therefore look for support to hold in this 0.5910/30 region to confirm NZD sellers are unwilling to re-establish downside bets.

Should NZDUSD price action continue to breakdown below 59 US cents, last week's bounce is nothing more than a false breakout, an overreaction.

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