By Stuart Talman, XE currency strategist
US inflation data for January has generated a mixed response from the market, evidenced by choppy price action in the few hours that followed. As we head into the second half of US trade, US equities are tipping over, dragging the new Zealand dollar back towards 63 US cents.
It was a goldilocks CPI report.
On the one hand, annualised CPI came in a little hotter than expected headline CPI printing at 6.4% (versus expectations of 6.2%), down from 6.5% in December. Headline inflation peaked at 9.1% in June.
The annualised core (ex-food & energy) reading also delivering a small upside beat at 5.6% (versus expectations of 5.5%), down from 5.7% in December. September was the peak for core inflation, at 6.6%.
Both MoM readings of 0.4% and 0.5% for core and headline respectively were in line with consensus forecasts.
Given the knee-jerk reaction that ensued, the market did not quite know how best to digest the report.
Having improved through yesterday’s local session, logging Tuesday afternoon highs a few pips shy of 0.6370, the Kiwi headed into the CPI release trading in a 0.6330/50 range. In the few minutes that followed, NZDUSD immediately spiked down to within a couple of pips of 63 US cents before spiking higher to almost touch 0.6390.
Still searching for direction an hour later, V-shaped price action ensued, the Kiwi falling from 0.6370 to a few pips below 0.63, before improving back to 0.6360.
Heading into the New York afternoon, NZD has improved back near 0.6350 as the three major US equity indices rebound from early session declines of around one percent.
Markets will likely focus on the narrative that inflation is higher (month-over-month) whilst politicians will highlight that price pressures are lower (year-over-year).
So, what about the Fed?
This CPI report shouldn’t move the needle for Jay Powell and his colleagues.
In the wake of the monstrous January payrolls report, the Fed is still on track to lift rates by 25bps in March (22) and May (03), bringing the Fed funds target rate to 5.00%-5.25%. Current market pricing assigns a greater than 90% chance to 0.25% at the next FOMC meeting.
Inflation is forecasted to meaningfully decline throughout 2023 as the largest component of the CPI basket, housing, is expected to pullback at a faster rate as we head into 2H. However, shelter remains at elevated levels, accounting for around half of the monthly CPI gain.
Now that we’re past the three major events of the first FOMC meeting for 2023, the January jobs report and January CPI, the market’s direction will be determined by the incoming dataflow.
Jay Powell and his FOMC colleagues made it abundantly clear following January’s FOMC – they remain vigilant and ready to act, the trigger finger remains flexed. Yet for all the hawkish rhetoric that the market absorbed, the large directional move was caused by the white-hot jobs report.
It’s a sign that Fed-speak will no longer influence short to medium term direction, rather key readings of economic activity.
There are three scenarios for the market…..
One, macroeconomic data, in particular jobs data, (continues) to surprise to the upside, requiring the Fed to prolong the tightening cycle, resulting in a terminal Fed funds rate higher than current expectations (~5.25%).
Sustained Feed hawkishness likely to dampen the stock market rally, pro-cyclical currencies including the New Zealand & Australian dollars underperform.
Two, the data flow is in-line or moderately softer.
Risk assets desired outcome….the fabled soft landing or mild recession the expected outcome.
Three, the incoming data abruptly deteriorates leading to a deep, ugly, and protracted recession that many market participants have moved to discount through early 2023 action.
US equities and risk assets plunge to the downside, likely to re-challenge October’s cycle lows.
The next key data point drops in Wednesday’s overnight action – US retail sales for January. Household spending has been declining for the past two months, printing below consensus forecasts, Another downside miss this evening may cause the equity bulls to rethink their soft-landing narrative.
In other news from Tuesday’s action, the pound was one of the stronger performers of the majors, higher than expected wages growth likely setting the scene for a 25bps hike from the Bank of England at its next policy meeting on 23 March.
Whilst NZDGBP continues to trade in a prevailing range that has contained price action for the past few months, the pair is testing key support, located near 0.52. Until we see a break below 0.5150 or a surge through 0.5300, the outlook for the pair remains neutral.
In addition to the US retail sales data, UK CPI is Wednesday’s major tier 1 data event. UK inflation is expected to fall further to an annualised 10.3%, logging its third month of declines after peaking at 11.1% in October.
Whilst the US CPI report failed to deliver a range breakout, the retail sales number also has the potential to do so should the outcome materially deviate from the consensus forecast.
Kiwi dollar price action remains entrenched in a 0.63 – 0.64 range, awaiting its next directional cue. Given the recent softness in US household spending, we favour a soft retail sales number, resulting in a challenge to sub 0.63 levels.
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Stuart Talman is Director of Sales at XE. You can contact him here.
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