US CPI runs hot, core inflation remains at 3.9%, reducing likelihood of May cut. US treasury yields and the dollar rip higher, 10-yr yield approaches 4.30%. UK unemployment falls from 4.2% to 3.8%; BoE likely not cutting until 2H

By Stuart Talman, XE currency strategist

A hotter-than-expected US CPI report has hammered the final nail in the coffin for a March rate cut whilst also tipping the odds in favour of the Fed maintaining a 5.25% - 5.50% target rate at the 01 May FOMC meeting.

US treasury yields have ripped higher, the yield on the benchmark 10-year note staging a technically important topside breakout through 4.20% to fall just shy of touching 4.30%, its highest level since early December.

In turn, the dollar is stronger across the board, resuming its rapid rebound from late December lows, having notably slowed its ascent, last week. The dollar index (DXY), a weighted measure of the USD versus 6 major currencies (and heavily weighted to the EUR) approaches 105.00, now over 4% higher from the 28 December low.

Both the 100-day moving average and the mid-point (located near 104.00) of the October-December downswing provided support over the past 5 trading days. With price action leaping higher to trade through 104.78, the 61.8% Fibonacci retracement, the technicals signal further upside ahead for the dollar.

Commencing the new week threatening a topside break of the 3-week range, the New Zealand dollar has been crunched by around one-and-a-third percent, plunging back below 61 US cents to mark intraday lows near 0.6050.

Whilst risks have shifted back to the downside, we're yet to see NZDUSD breach the 0.6040/60 support zone that we flagged (in yesterday's update) as a critical floor for the pair. 

Certainly, if the macroeconomic data flow out of the US continues to run hotter than consensus and the projection for the timing of the Fed's first rate cut continues to be pushed back later into the year, the dollar will continue to outperform, driving the Kiwi below 60 US cents.

Printing at 0.3% month-on-month (vs 0.2%, expected), to yield an annualised reading of 3.1% (vs 2.9%, expected), hopes were dashed that headline inflation would dip below 3% for the first time since early 2021. Core inflation (stripping out volatile food and energy prices) climbed 0.4% MoM (vs 0.3%, expected) to maintain a year-on-year reading of 3.9%.

Over the past four months, annualised core CPI has printed at 4%, 4%, 3.9%, and 3.9%.

Central bank officials, in recent months, have referred to the last mile, in their ongoing battle against inflation - the challenges that may present in sustaining disinflationary forces to return inflation to targeted levels, late in the cycle. 

They are wary of past battles, notably in the late 70's and 80's when central banks were too hasty to end monetary tightening cycles, presuming the job had been done, only to see a second inflationary wave materialise.

January's CPI report is at odds with the Fed's preferred inflation gauge, the core PCE deflator which has been trending lower at a noteworthy rate over the past 6 months.

Why the divergence?

The CPI calculations assigns a significantly greater weight (relative to PCE) to owner's equivalent rent (OER) - a measure of the amount of rent that would have to be paid in order to substitute a currently owned house as a rental property.

OER climbed by 0.6% in January, its quickest rate of increase in several months. Given it has the highest weighting in the CPI basket, an OER resurgence is of huge concern for the Fed. 

The bottom line: the Fed will most certainly not be cutting the Fed funds target rate on 20 March, and unless the macro data flow deteriorates over the next couple of months, is unlikely to do so at the 01 May FOMC meeting. The Fed will receive two more CPI reports (12 MAR. & 10 APR.) ahead of May's decision.

The main takeaway from this CPI report regarding the currency market - don't expect the dollar's fortunes to change through the remainder of 1Q……in turn, the New Zealand dollar's bias will continue to lean neutral to negative.

In other news from Tuesday, a busy week of UK data has commenced with December's labour market report.

Firstly, a caveat, the UK's Office for National Statistics recently reweighted the calculation of jobs data, leading many an analyst to question the report's near-term reliability.

In any event, December's data has exceeded consensus estimates, the unemployment rate falling from 4.2% to 3.8% (vs 4%, expected) whilst regular pay (ex-bonuses) did fall from 6.7% to 6.2%, but not to the same extent as projected.

The data does little to alter the Bank of England's psyche, yet another central bank that is in no rush to commence monetary easing. Market pricing currently projects three BoE cuts this year, commencing in early 2H.

The pound was one of the better performing currencies through Tuesday, declining only a third-of-a percent versus the US dollar, continuing its run as the strongest year-to-date performer amongst the G10 (aside from the dollar).

Falling around one percent, NZDGBP has lost all topside momentum having rebounded over 2% from the 23 January swing low a few pips below 0.4780. Peaking in the 0.4870's late last week, Tuesday's decline has driven the pair back into the low 0.48's.  

A break below trendline support and both the 100- and 200-day moving averages suggests the pair may be headed for a re-test of critical support located at 0.4770.

Looking to the day ahead, UK CPI is the headliner, core inflation expected to tick up from 5.1% to 5.2% whilst headline climbs from 4% to 4.2%. Should UK CPI also run hotter than consensus, NZDGBP will plunge below 0.4800.

Eurozone GDP is the other tier 1 data point in focus.

Tuesday's sell-off was the second largest NZDUSD intraday decline this year……will NZD bulls drive the pair below the 0.6040/60 support zone or will the prevailing range hold?

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