Despite Powell kiboshing March cut, yields continue to fall, dollar reverses. Eurozone core inflation falls from 3.4% to 3.3%; headline remains sub-3%. Bank of England delivers hawkish hold; odds of May cut fall below 50%

By Stuart Talman, XE currency strategist

In the wake of Wednesday's hawkish hold from the Fed, the dollar has handed back some gains as US treasury yields continue to head south. Despite Fed Chair Powell pouring water on a March cut, the yield on the benchmark 10-year note failed to regain a foothold above 4.00%, falling for a fourth consecutive day, nearing 3.80%.

Re-testing levels below 61 US cents, the New Zealand dollar was offered throughout the Asian afternoon and into the first half of European trade as the dollar continued to firm following Fed Chair Powell's hawkish press conference, Thursday morning.

The key moment in the FOMC presser occurred when Powell was asked if he thought it was premature to think that rate cuts are around the corner. He responded by commenting that he felt the committee had yet to reach a level of confidence to identify March as the meeting to commence cutting.

This followed a key line in a new look statement of monetary policy that included:

The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent.

Much of the focus in the press conference via journalists’ questions was what Powell and his FOMC colleagues needed to see to gain greater confidence.

Simply, to paraphrase Powell: macroeconomic data flow that confirmed growth and inflation continues to move into better balance.

Given the first FOMC meeting for the year compelled market participants to push back the expected timing of the rate cutting cycle, the mix of the statement and presser was regarded as a hawkish update. Consensus amongst the analyst community is for a 25 bps cut to materialise at the May or June meetings.

Following the conclusion of the presser, NZDUSD fell to within a pip or so of 61 US cents, having climbed into 0.6160's during Powell's prepared remarks and answers to initial questions.

The Kiwi continued to be pressured throughout local trade, and into the London morning, touching 0.6080 at intraday lows.

Earlier in the week we flagged 0.6060/90 as a key NZDUSD support zone:

Last week's swing low was marked a couple of pips above 0.6060 whilst the mid-point of the October to December upswing is located at 0.6071. On multiple occasions over the past two weeks, intraday lows have traded within close proximity to 0.6090. 

A break below this region would be a notable bearish technical development, likely guiding a path for the Kiwi to test the 100-day moving average, located near 0.6040 and below here, the 61.8% Fibonacci retracement at 0.6001.

Heading into overnight trade, it appeared the Kiwi was set to test the lower bound of the support zone.

However, the first half of US trade has delivered a sharp rebound, the Kiwi rapidly recouping the day's losses and venturing into the green, improving back to 0.6140.

The pair remains entrenched in a prevailing range that has evolved over the past half-dozen trading days, constraining much of the price action between 0.6080 and 0.6150.

The path for the USD in the months ahead will be determined by the Fed achieving greater confidence that inflation will remain at 2% for a sustained period. Should disinflation stall whilst the macroeconomic data flow remains resilient, the Fed will not be cutting during 1H - the dollar will, at the very least remain flat or extend its first quarter rebound.

A well supported dollar would cap the New Zealand's dollar's upside in the low 0.60's with a probable re-test of sub 60 US cent levels.

Conversely, should key inflation and growth/activity data points track lower whilst the unemployment rate climbs through 4% (currently 3.7%), the Fed cuts before the northern hemisphere summer, likely ushering in a period of sustained USD weakness.

Via this scenario, the New Zealand dollar ascends through 65 US cents and beyond.

Heading across the North Atlantic, the two major events from Thursday were the Bank of England's first monetary policy meeting for 2024 and the January CPI report for the eurozone economy.

Core inflation in the EU came in a little hotter than expected falling from 3.4% to 3.3% (vs 3.2%, expected) whilst the annualised headline rate met expectations, falling from 2.9% to 2.8%. Whilst softer energy prices have aided headline inflation falling below 3%, disinflationary forces have been slowing in recent months. February ushers in a seasonally strong period for crude, heightening the risk that downside price pressures evaporate.

In short, it's still too early to declare victory over inflation - the ECB, like the Fed, is in no rush to commence cutting.

Ranging between 0.5580 and 0.5750 over the past two month, NZDEUR has stalled around the midpoint of the range, following a late January rebound.

We suspect the pair will continue to remain rangebound throughout the remainder of 1Q as the market awaits further data that will shape expectations for ECB policy. The consensus amongst analysts projects the first ECB cut to be delivered in June or July.

As widely expected, the Bank of England has left the bank rate unchanged, the key takeaways:

• BoE maintains 5.25% bank rate
• Vote split: 6(hold)-2(hike)-1(cut)
• Remains concerned regarding persistent inflation

Given the market was positioned for a dovish on-hold update, the mix of the BoE's statement and vote-split has been received as mildly hawkish. BoE hawks, Mann and Haskel retained their preference for rate hikes whilst the statement acknowledged that despite notable progress in lowering inflation, levels remain too elevated for comfort:

In the Committee’s February forecast, the risks to inflation are more balanced. Although services price inflation and wage growth have fallen by somewhat more than expected, key indicators of inflation persistence remain elevated.

The BoE retained its higher-for-longer mantra via:

As a result, monetary policy will need to remain restrictive for sufficiently long to return inflation to the 2% target sustainably in the medium term in line with the MPC’s remit. The Committee has judged since last autumn that monetary policy needs to be restrictive for an extended period of time until the risk of inflation becoming embedded above the 2% target dissipates.

The market response: implied odds of a May cut fell below 50% (from around 70%) with June firming as the likely meeting that commences the easing cycle.

Having rebounded from near 0.4780 through 0.4840 over the past half-dozen trading days, NZDGBP eased back to within a few pips of 0.4800 through Thursday's sessions. A topside break through 0.4780 would also coincide with price action moving back above the 200-day moving average - required to shift short term momentum from neutral to positive.

Looking to the day ahead, the week's second most important event, the January US employment report is released. With around 180K new jobs expected, a non-farm payrolls data point at 200K+ would drive the dollar higher whilst a sub-150K reading emboldens USD sellers.

The unemployment rate is projected to tick up from 3.7% to 3.85 whilst average hourly earnings is expected to fall from 0.4% to 0.3%, month-on-month.

A weekly close above 0.6150 should be regarded as a win for the NZD bulls, potentially opening a path for NZDUSD to commence forming a higher range. Conversely, price action venturing back below 0.6080 suggests further downside ahead.

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