By Stuart Talman, XE currency strategist
Given it’s the first Morning Update for 2024, the Xe team wishes you a very Happy New Year! We hope you all had a relaxing and enjoyable holiday break with family and friends and start the new year recharged and refreshed.
All the best for the year ahead!
When we signed off in the second to last week in December, the dominant story line for financial markets was the Fed's surprise dovish pivot. At the 13 December FOMC meeting Fed chair Powell and the December dot plots informed the market the Fed had shifted from considering if rates were sufficiently restrictive to laying out a path for the easing cycle to commence. The updated median dot plot projecting three 25bps rate cuts throughout 2024.
This provided the greenlight for risk assets to extend fourth quarter gains, US equity markets rallying into year-end as the yield on the benchmark 10-year note fell through 3.80%, placing further downside pressure on the dollar.
As the market moved to price in a Fed rate cut as early as March and some 160bps of 2024 easing, high beta currencies, including the New Zealand dollar, outperformed.
Having marked its 2024 low a few pips above 0.5770 in late October, the New Zealand dollar ripped higher throughout November and December as the market concluded the Fed's tightening cycle was done, NZDUSD adding over 10% to peak within a pip or so of 0.6370 on the penultimate trading day for 2024.
Closing 2024 within a few pips of 0.6320, the Kiwi's net move for the year was a modest decline having ended 2022 near 0.6350.
The consensus pick for the year ahead is further US dollar weakness as the Fed is expected to defy history by delivering a soft landing whilst returning inflation back to its 2% target.
Commodity currencies are projected to outperform on the assumption commodity prices are likely boosted by a weaker dollar and the global economy's growth prospects brighten as central banks across the globe lower their respective policy rates.
Of course, it would be short sighted to oversubscribe to this view given the complexities of the global economy and the increasingly volatile geopolitical backdrop.
The start to the new year has seen some of the dollar's weakness unwound, the market seemingly reassessing December's dovish repricing of Fed policy in 2024.
A couple of weeks ago rates markets were projecting circa 160bps of Fed cuts for the year ahead with the first cut expected at the 20 March FOMC meeting. Acknowledging that it may have gotten too far over its skis, market pricing has stripped out close to a full 25bps cut, pricing in ~140bps of monetary easing with the easing cycle to commence at the 01 May meeting.
Comparing this to the market's pricing for RBNZ policy, 85bps of cuts are projected with the Adrian Orr and his fellow board members to commence easing at the 10 July MPR.
Market repricing dialling back the speed and magnitude of 2024 rate cuts has been the catalyst for the yield on the US 10-year to reclaim territory north of 4.00%, in turn inducing a new year rebound for the USD, the dollar index (DXY) rebounding from the 100.60's to peak through 103.00 at Friday's swing highs.
Back in early October the DXY's apex was marked above 107.00 with the 10-year yield peaking through 5.00% a couple of weeks later as the Fed sent the message that additional monetary tightening may be required.
Now the focus is squarely on the timing of the first cut.
This evening delivers the US CPI report for December, core inflation expected at +0.3% month-on-month for an annualised rate of 3.8%. Both October and November printed at 4%. Core CPI has not printed below 4% since May 2021. Should core prices reach further and further below 4% through 1Q, whilst the labour market continues to soften, calls for a May cut likely prove correct.
Headline inflation is expected to print at 3.2%, year-on-year.
A soft CPI report will re-ignite the risk rally driving the S&P500 through its all-time high, recorded in January, 2022. The Nasdaq and Dow have already logged fresh record highs through December.
The pro-cyclical New Zealand dollar would reclaim territory north of 63 US cents, opening a path to test a critical resistance zone located at 0.6370 - 0.6400.
A decisive break through here sets up a test of 2023's high a couple of pips shy of 0.6540.
Conversely a CPI beat may induce a wave of selling as market participants further distance themselves from December's dovish bets. In this scenario, NZDUSD may pull back to the 200-day moving average, currently located near 61 US cents.
Of course, the third scenario is an in-line CPI report, leading risk assets to continue to consolidate near recent swing highs the market awaits the first FOMC meeting for the year on 31 January.
For the day ahead, the only other data point of note is trade data across the Tasman which follows on from the release of yesterday's monthly CPI number for the Australian economy. Monthly inflation fell from 4.9% to 4.3% (vs 4.4%, expected), adding to the case for the RBA to maintain the cash rate at 4.35%.
Current market pricing projects less than 50 bps of monetary easing for the year ahead with RBA Governor Michelle Bullock delivering the first cut sometime in early 3Q.
Having peaked near 0.9380 in early December, NZDAUD has ranged between 0.9220 and Tuesday's peak in the 0.9330's over the past few weeks.
The RBA is the first of the antipodean central banks to convene, delivering its first interest rate decision for 2024 on 06 February. Market pricing assigns a greater than 95% implied probability of an on-hold decision.
Expectations for the next 24hours, assuming an in-line US CPI report - the Kiwi to continue to trade between 62 and 63 US cents.
Stuart Talman is Director of Sales at XE. You can contact him here.
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