US CPI was lower than expectations for the fourth consecutive month, USD majors index is down 0.7%, US rates recovered losses to close 1 bps lower; NZD made the smallest gain of all majors against the USD, up 0.4%; local rate curve steepened on Friday

By Jason Wong

The focus for the market on Friday was the much-anticipated US CPI release.  Core CPI inflation surprised to the downside for the fourth consecutive month, with the annual increase of 1.7% remaining at a 2-year low.  There was a trifecta of soft economic releases, with retail sales and consumer sentiment also underwhelming, the latter falling to a 9-month low.

The USD was under pressure for much of last week, and the weak CPI outturn resulted in another lurch down.  The USD majors index ended the day down 0.7%, and down 1.2% for the week, taking it to its lowest level in ten months. The weaker USD helped drive the S&P500 up 0.5%, taking it to a fresh record high, while the VIX index fell to 9.5, its lowest close since 1993.

While the data had a sustained impact on the USD and equity market, the impact on the bond market was only temporary.  The US 10-year Treasury rate was 2.33% ahead of the CPI release and it fell 5bps to 2.28%, before recovering to close the day back at 2.33% just 1bp lower compared to the NZ close. The 2-year rate followed a similar pattern.

Expectations for further Fed hikes this year barely changed, with the market pricing in slightly less than a 50/50 chance of another 25bps hike before the end of the year.  The broadly-based nature of the recent weakness in the core CPI raises some doubt about how “temporary” the slowdown is but there are still five more monthly releases before the December meeting along with another five potentially strong employment releases.  Abandoning calls for further Fed tightening this year would therefore appear premature.  Most believe that a Q3 pause in the hiking cycle is likely anyway, as some reduction in the Fed’s balance sheet takes priority.

All major currencies rose against the USD, with the NZD showing the smallest gain, up only 0.4% for the session to close just under 0.7350, a key level of technical resistance.  Rising risk appetite has pushed our fair value estimate up to 0.7590, but we still have some doubt over whether the NZD will reach such a height this year.  The NZD remains vulnerable to any negative news, with net speculative long positioning remaining near a four-year high.  The last time speculative positioning was this one-sided, in April 2013, the NZD fell from 0.86 to 0.77 or around 10% over the subsequent three months.

At the other end of the leaderboard, the AUD was the biggest beneficiary of the soft USD, continuing its strong run, up 1.3% to fresh high of 0.7830 and up over 3% for the week.  It’s not often you see such a wide dispersion between NZD and AUD performance, on no specific NZ or Australia news, so that’s a bit of a head-scratcher.  NZD/AUD fell 0.9%, closing at a 7-week low of 0.9380.

GBP also put in a particularly strong performance, breaking up through 1.31 at one stage, a level it hasn’t seen since September.  There is growing speculation that the Bank of England will be the next major central bank to hike rates, although more likely early next year than something for 2017.  NZD/GBP closed the week just above 0.56.  Being one of the weakest performers, the NZD was lower on the other major crosses, closing the week just above EUR 0.64 and NZD/JPY closing around 82.7.

NZ’s swap curve steepened slightly on Friday, with global forces pushing up longer dated yields, with the 10-year rate up 2.5bps to 3.36% and the 2-year rate flat at 2.27% ahead of tomorrow’s NZ CPI release.  Market expectations are centred on a soft 0.2% q/q outturn and BNZ’s estimate is slightly below that at 0.1% q/q, a recipe for the RBNZ maintaining its neutral policy stance for some time to come.  Today sees the release of China activity data, where expectations are for little change in momentum, while the calendar for tonight is bare.

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