US CPI runs hot for a 3rd month; headline rises. Implied probability of a June Fed cut falls from 50/50 to below 20%. RBNZ hold decision passes with minimal reaction; balanced view maintained

By Stuart Talman, XE currency strategist

The Fed ain't cutting in June……and may well not be cutting at all in 2024.

For a third consecutive month US CPI has surprised to the upside, both the headline and core readings replicating January's and February's 0.4% month-on-month result (vs 0.3%, expected), running at more than double the monthly run-rate that is required to return inflation to the Fed's 2% target.

Disinflationary forces have clearly stalled - annualised headline CPI printing at 3.1%, 3.2% and now 3.5% through the first three months of 2024, whilst annualised core bottoms out just below 4%, printing at 3.9%, 3.8% and 3.8% during this span.

At the 20 March FOMC meeting, in which Powell adopted a surprisingly dovish tone, the Fed chair made it clear that he was not worried about the higher-than-expected inflation readings in January and February. Regarding the January data, Powell commented:

There is reason to think there could be seasonal effects there, but nonetheless we don’t want to be completely dismissive about it.

He went on to add that February's CPI outcome was also not terrible, stating in his FOMC presser:

The two of them together, they haven’t really changed the overall story, that of inflation moving down gradually on a sometimes-bumpy road to 2%. I don't think that story has changed.

Three consecutive months of hot data cannot be attributed to seasonals…..rather, it’s a trend.

Inflation is bottoming out significantly higher than the Fed's 2% target.

The latest reading on consumer inflation will surely force Powell and his FOMC colleagues to re-think the path for monetary easing, questioning whether rate cuts are required at all…..maybe even questioning whether a 5.25%  - 5.50% Fed funds target rate is sufficiently restrictive.

The implied probability of a 25 bps cut at the 12 June FOMC meeting had fallen to a near 50/50 proposition following las week's blowout non-farm payrolls report. Earlier in the year, odds were greater than 90% for the Fed to commence its easing cycle in June.

Now, Fed funds futures assign a less than 20% probability the target rate is lowered to 5.00% - 5.25% in June.

Whilst it would be premature to totally rule out a June cut given two more jobs reports and two additional CPI reports (the second on the same day as the 12 June FOMC meeting) are delivered, the reality is a seismic shift in economic activity would be required to deliver a substantial drop in jobs growth and prices.

The market reaction to the March CPI data?

The yield on the benchmark 10-year note has ripped higher by almost 20 bps, leaping through the 4.50% mark for the first time since mid-November when the pullback from 16+ year highs above 5% was gaining momentum.

In turn the dollar logs widespread outsized gains, the dollar index (DXY) smashing through major resistance at 105.00. In Monday's update we commented:

The DXY's upside had been capped around 105.00, early last week, as it was in mid-February, tentatively signalling the formation of a double top. Should this reversal pattern be invalidated via the DXY springboarding through 105.00 in the short to medium term, the New Zealand dollar would fail to maintain a foothold above 60 US cents.

Should DXY extend higher in the days ahead, consolidating above 105.00, expect a test of the 2023 high in the 107.30's, ushering in a fresh wave of USD strength.

Falling over one-and-a-third percent, the New Zealand dollar once again plumbs sub-0.60 levels.

Having rebounded close to 2.5% off the 01 April low at 0.5940, NZD/USD looked willing to regain a foothold within the 0.6050 - 0.6220 range that had evolved through the first three months of 2024.

However, the CPI induced plunge from the 0.6080's through 0.5970 has invalidated the past two week's recovery and could prove to be the catalyst that opens a path to test the 2023 low, located a few pips above 0.5773.

Should the US exceptionalism narrative continue into mid-year, the New Zealand dollar trading in the 0.57 - 0.58 region is not an unfathomable outcome.

The other major event from Wednesday, the RBNZ's interest rate decision, unsurprisingly passed with minimal impact. The key takeaways:

• RBNZ on hold, maintains 5.50% OCR
• OCR required to remain restrictive for a sustained period
• Balanced view acknowledges both upside & downside risks to inflation

 As universally expected, Governor Orr and his fellow board members maintained current policy settings and similar messaging in a notably condensed accompanying statement, which concluded with:

Economic growth in New Zealand remains weak. While some near-term price pressures remain, the Committee is confident that maintaining the OCR at a restrictive level for a sustained period will return consumer price inflation to within the 1 to 3 percent target range this calendar year.

The statement of record (aka minutes) presented a balanced view: upside inflation risks acknowledged via reference to monthly Selected Price Indices (SPI) imply some upside risk to the March 2024 quarter Consumers Price Index (CPI). A nod to downside risks to the inflation outlook was flagged via the reference to weakening global growth due to the impact of restrictive monetary policy.

The market reaction was minimal but given the slightly higher NZD/USD immediately following the release, suggestive that market participants were anticipating a more dovish tone.

Market pricing currently assigns circa 60 bps of easing before the end of the year with timing of the first cut expected sometime in late 3Q, or early 4Q.

Looking to the day ahead, the ECB interest rate decision is the main event. Expectations are for the eurozone central bank to deliver a moderately dovish on-hold decision, signalling that a June cut is on the table.

The Kiwi had been clawing back some ground versus the euro, touching 0.56 in the run up to the US CPI data before shedding ~40 pips to commence Thursday's local session near 0.5560. We look for the 28 March swing low through 0.5530 to remain unchallenged as the pair feeds back up into the 0.5600 - 0.5750 region as we enter 2H.

We'll also be on JPY intervention watch today given USD/JPY punched through 152.00 to fall just shy of touching 153.00. Should the JPY continue to weaken, the Ministry of Finance will surely enact its intervention protocols.

Currently trading in the mid to low 91.00's, NZD/JPY likely falls in the region of 2% to 4% in the event of MoF intervention, sliding below 89.00.

As for NZD/USD, the US CPI has bottomed narrative will now be front and centre, driving the pair further below 60 US cents.

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