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US PPI beat: producer prices rise most in 6 months; follows hot CPI. US treasury yields rip higher, 10-year back near 4.30%; US dollar stronger Odds of a June cut lower as sticky inflation may delay the easing cycle

Currencies / analysis
US PPI beat: producer prices rise most in 6 months; follows hot CPI. US treasury yields rip higher, 10-year back near 4.30%; US dollar stronger Odds of a June cut lower as sticky inflation may delay the easing cycle
inflation rises unexpectedly

By Stuart Talman, XE currency strategist

Hot PPI data has followed the steamy CPI report from earlier in the week, producer prices rising by 0.6% (vs 0.3%, expected) month-on-month in February - the largest increase since August.  Annualised PPI climbed from 1% to 1.6% whilst core PPI remained steady at 2%.

US treasury yields have ripped higher in response, the yield on the benchmark 10-year note leaping from below 4.20% to just shy of 4.30%. Late last week, the yield had fallen through 4.04% off the back of Powell's 2-day congressional testimony in which the Fed Chair again reminded the patience is required and cuts will be coming later in the year.

This week's CPI and PPI upside beats has forced a rethink for rates markets, dialling back the amount of cumulative tightening projected into year-end. Heading into this week, the market was aligned with the Fed, projecting 3 x 25bps cuts…..this week's hawkish re-pricing now closer to 2 x cuts.

Advancing for a fourth consecutive day, a higher 10-year note yield has induced a US dollar bounce, the dollar index (DXY) locating support around 102.70 through the first three days of the week before advancing through 103.00 to mark Thursday's highs near 103.40.

The price action suggests the DXY could break higher through trendline resistance to test the convergence of the 100- and 200-day moving averages, located near 103.70.

Implications for the New Zealand dollar?

This week's NZD/USD price action has validated Friday's unsustainable spike through 62 US cents as a double top (with the 22 February high), confirming that NZD bulls are unwilling to drive the pair beyond 0.6220 resistance.

The 0.6050 to 0.6220 8-week range continues to frame sideways price action.

Prior to the release of the PPI data, NZD/USD had mostly ranged between 0.6150 and 0.6170 before shedding ~50pips to mark intraday lows a few pips above 0.6120.

With an FOMC meeting delivering the latest set of dot-plots, next week, could we see a range breakout?

The median December dot plot (a record of where each FOMC official projects the level of the Fed Funds target rate at year-end) projected 3 x 25 bps hikes by year-end. Given two-months of CPI beats, the March median dot-plot could be lowered to 2 cuts as Powell again stresses that patience is required.

In this scenario, US treasury yields and the dollar extend their run higher, the Kiwi falls back below 61 US cents to set up a re-test of major support at 0.6050.

Whilst recent key inflation reads add weight to the case for the Fed Funds target rate to remain on hold at 5.25% - 5.50%, other tier 1 data points are indicative of a US economy that, whilst healthy, continues to cool.

Retail sales, also released Thursday rose 0.6% month-on-month through February, missing the consensus 0.8%. In addition, January's result was revised lower to record a larger decline, suggesting that household spending is notably slowing.

The retail sales data along with last Friday's higher unemployment rate and recent PMI misses signals softening growth in the world's largest economy.

So, on the one had you have sticky inflation that requires the Fed to maintain the higher-for-longer setting, but on the other, you have activity data that implies 500+ bps of cumulative tightening is now having the desired effect.

The outlook for Fed policy is murky.

The election campaign will also likely factor into the Fed's considerations.

If CPI/PPI/PCE all remain at or near current levels over the next few months, whist activity data steadies, the Fed won't be cutting in June……and then may not cut until after the November election.

Current market pricing assigns a near 40% implied probability the target rate remains at 5.25% - 5.50% in June……odds that have been climbing.

Should this dynamic sustain, don’t be surprised to see a downside range breakout for the New Zealand dollar in the months ahead, testing sub-0.6000 levels.

Looking to the day ahead, the domestic calendar presents the Business NZ manufacturing PMI which has printed in contractionary territory (sub-50.0 reading) for the past 12 months, although did significantly improve in January climbing from 43.4 to 47.3.

A quiet offshore calendar delivers tier 2 manufacturing data out of the US and the updated reading of the University of Michigan's widely followed consumer sentiment index.

We suspect Friday's session may prove uneventful as the market anticipates next week's headliners - the BoJ and Fed meetings.

Expectations are for the Kiwi to end a down week in the low to mid 0.61's.

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

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