Softer headline & core US CPI validates peak rate calls; Fed looks to be done. US bond yields sink, 10-yr plunges below 4.50%. Risk on: US equity markets rocket higher

By Stuart Talman, XE currency strategist

Following two months of hotter than expected (headline) inflation prints, the US October CPI report has undershot consensus forecasts, further bolstering the market's base case the Fed's July hike (to 5.25% - 5.50%) was the last of the cycle and that disinflation and a cooling US economy will induce rate cuts in late 1H 2024.

The dollar has been crunched as the yield on the benchmark 10-year note plunged below 4.50%, marking intraday lows near 4.43%, its lowest mark in 9 weeks, unwinding around two-thirds of the rapid ascension in rates witnessed throughout September and October.

The New Zealand dollar took flight, adding around 120pips, rocketing higher from below 0.5870 to within a couple pips of 60 US cents, surpassing the 06 January result for the largest intraday gain for 2023.

The mammoth directional moves have induced significant downside range breakouts for both the US 10-year yield and the dollar index, potentially signalling a pivotal moment in which the dollar's ascendancy has ceased.

Following recent soft PMIs and a downside nonfarm payrolls miss, earlier in the month, the macroeconomic data flow for the US economy appears to be deteriorating in an orderly fashion, but more evidence is required to confirm the world's largest economy is finally starting to buckle under the weight of 525bps of cumulative monetary tightening.

Should further evidence present as 2023 draws to a close, the dollar will continue to weaken, setting the scene for a seasonal year-end rally for risk sensitive assets, including the New Zealand dollar.

The three major US equity indices have cheered the soft inflation numbers - the S&P500 and Nasdaq up close to 2% whilst the Dow adds around 1.50%.  From late October lows, the S&P500 has ripped higher, advancing close to 10% whilst the Nasdaq has outperformed as bond yields have aggressively u-turned, climbing over 12% during this span.

So, lets dig into the details of the October CPI report.

Both headline and core inflation surprised to the downside, the month-on-month headline rate flat through October (vs 0.1%, expected) yielding an annualised reading of 3.2% (vs 3.3%, expected). Headline inflation in the two months prior printed at 3.7%, above expectations, therefore October's decline is significant, aided by a shar pullback in energy prices due to the containment of the Israel-Hamas conflict.

Core inflation printed at 0.2% MoM, 4% annualised (vs 0.3% & 4.1%, expected), the softer-than-expected result largely due to further disinflation in CPI's largest component - owners' equivalent rent (housing). Used car prices, airfares and hotel prices were also notable decliners.

Encouragingly for the Fed, their "supercore" measure of inflation, which strips out energy and housing prices fell below 4%. This measure of inflation is a key consideration for Fed policy as it is directly influenced by labour market tightness and higher wages.

Market pricing adjusted accordingly, with close to a 100% implied probability assigned to on-hold decisions at both the 13 December and 31 January FOMC meetings. Rate cuts are projected (by Fed funds futures) to commence around June with circa 90bps of easing through to year-end 2024.

More FOMC officials are scheduled to speak this week and next…..will they shift to a more dovish tone?

If they do, expect further downside for the dollar, in turn, the New Zealand dollar re-establishing a foothold above 60 US cents.

In other news from Tuesday, the UK employment data for October has reported a modest pullback in wages growth, regular pay (excluding bonuses) fell from 7.9% to 7.7%, the first wage inflation decline since January. The unemployment rate remained steady at 4.2%.

The Bank of England last hiked the bank rate to 5.25% in August. This modestly softer jobs report is good news for the BoE, universally expected to deliver another on-hold decision at the final monetary policy meeting for the year on 14 December.

Gaining over a third-of-a-percent, NZDGBP again bounced off 0.4770 support, the third time the pair’s downside has been halted at this level over the past few weeks.

Should the risk-on vibes continue into year-end, we expect NZDGBP to re-test the 03 November swing high near 0.4860 before targeting the 200-day moving average, currently located in the low 0.4900’s.

Looking to the day ahead, a busy economic calendar delivers numerous tier 1 data releases. Regionally, the focus will be on China activity data before the attention turns to UK CPI – core expected to fall from 6.1% to 5.8%.

Retail sales in the US is the day’s headliner, the consensus calling for a -0.1% decline following September’s +0.7% growth. A modest downside miss would extend today’s risk rally, albeit not to the same magnitude.

Having failed at 60 US cents early last week, NZDUSD is primed to stage a meaningful topside break through the 0.6000/50 resistance zone that has capped the pair’s upside over the past three months.

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