By Stuart Talman, XE currency strategist
The dollar weakness camp had been swelling in numbers in recent weeks, many in the analyst community favouring a prolonged run lower for USD given the notably slower macro data flow through 2Q, suggesting a period of more sluggish nominal growth was evolving.
It looked to be the right call as the New Zealand dollar and several of its major peers probed the top of multi-month ranges, primed for their respective topside breakouts.
However, Friday's eye-opening jobs numbers ignited a fierce US dollar rally, crunching the Kiwi by around one-and-a-half-percent, abruptly ending its attempt to regain an important foothold above 62 US cents.
A blockbuster nonfarm payrolls beat and higher average hourly earnings catapulted US treasury yields higher as rates markets dialled back pricing for Fed cuts, prompting the dollar bears to rethink their negative views.
All but matching the largest intraday decline, year-to-date, NZD/USD plunged from within a pip or so of 0.62 immediately prior to the BLS data, shedding circa 50 pips in quick time. Selling pressures were sustained throughout US trade, adding a further 50 pips of downside, the Kiwi spiralling to close the week a pip or so from 61 US cents.
Three prominent weekly highs formed in late February, early March, and now early June have all been logged within 5 pips of 0.6220, a critical hurdle that must be cleared to usher in a new period of New Zealand dollar strength.
For the time being, the hurdle presents as too high.
This week will likely confirm the directional bias heading into the second half of the year, a bumper Wednesday delivering both US CPI and an FOMC decision, that includes updated Fed forecasts (dot plots) within a half dozen hours of each event.
The Fed is likely to be hawkish, the median dot plot expected to record the FOMC now projects two rate cuts (perhaps just one) before year-end, down from three.
Annualised core inflation is forecasted to ease from 3.6% to 3.5% whilst headline remains steady at 3.4%.
The CPI data is arguably more important than the FOMC meeting, likely to have more of an influence on short-term direction should it deviate from consensus. Should inflation again surprise higher as it did for the first three months of the year (April's was in-line), the dollar will reassert its dominance as the market moves closer to pricing in zero cuts.
Conversely, a softer-than-expected CPI print would reverse Friday's job induced USD rally, raising hopes for a Fed cut in September.
At present, prices data (PCE, CPI, PPI) carries a significantly heavier weighting than the labour market data for the Fed given sticky inflation remains worryingly elevated, failing to track towards the Fed's 2% target.
Depending on how you prioritise and slice and dice the employment data, one could mount a compelling argument in favour of a robust and resilient US jobs market or an alternative, equally compelling argument that centres on softening conditions.
Let's unpack that a little…..
On the surface, there was no denying the May data was hot. Nonfarm payrolls, at 272K (vs 185K, expected) comfortably exceeded all of the 77 forecasts submitted by economists to Bloomberg, the highest forecast being 258K. In addition, average hourly earnings climbed from 0.2%, month-on-month to 0.4% (vs 0.3%, expected), the highest reading in 5 months.
Both the NFP and wages data add to concerns that inflation will remain too far above the Fed's target, thereby delaying rate cuts until sometime in 2025. Prior to the employment data Secured Overnight Financing Rate (SOFR) futures implied 48 bps of easing by year end, falling to 38 basis points.
However, looking beneath the surface, there were undeniable weak elements to May's BLS labor market report.
The report is formed via two surveys: the establishment survey, derived from business data and the household survey - the name self-explanatory.
Divergence is a continuing theme between the two surveys.
The household survey reported a decline of 408,000(!), which does align with other recent soft data points, including JOLTS Job Openings, ADP Employment change and the ISM employment sub-gauges.
The household survey is used to compute the unemployment rate. Hence, despite the blowout NFP number, the jobless rate climbed from 3.9% to 4.0%, the first time a "4" handle has printed in close to 2½ years.
The point we're illustrating when it comes to the jobs data: one can interpret the data in way that aligns with the preferred narrative/outlook, a practice known as confirmation bias.
One could refer to the Kansas City Fed's Labor Market Conditions Indicators (LMCI) which measures employment conditions based on 24 labour market variables, thereby cutting through the noise of the vast amount of data points.
The LMCI peaked in early 2022 and has been trending softer thereafter.
But, at the end of the day it’s the headline numbers that have the most influence on the near-term path of the Federal Funds Target rate. May's hot report requires Jerome Powell and his colleagues to remain patient, perhaps delaying the first cycle cut until after the election.
This patience will ensure that bouts of dollar weakness remain contained for the time being.
Looking to the week ahead, in addition to Wednesday's CPI/FOMC double header, other notable events include the Bank of Japan meeting (likely no hike), jobs data for the UK and AUS and US producer prices (PPI).
We suspect the dollar my continue to claw back the losses of recent weeks on the assumption CPI prints in-line or hotter-than-consensus.
The likely outcome from the FOMC meeting - a hawkish hold.
If this proves correct, the Kiwi likely explores levels in the mid to low 0.60's.
It promises to be a lively week!
Stuart Talman is Director of Sales at XE. You can contact him here.
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