By Stuart Talman, XE currency strategist
In the run-up to Friday's Jackson Hole address, we had commented the bar was set high for Fed Chair Powell to out-dove the market given rates markets priced in comfortably more than 25bps for the 18 September FOMC meeting and around one percent of easing by year-end.
Powell leapt over that bar!
US treasury yields and the dollar headed south, the S&P500 and Nasdaq reversed most of Thursday's losses and pro-cyclical currencies outperformed - the New Zealand dollar sitting atop the G10 leaderboard, logging a whopping +1.63% intraday gain.
Leaping to within a few pips of 0.6240, NZD/USD surged to its highest level since 15 January as market participants viewed Powell's address through dovish lens.
As expected, Powell's comments locked in a September rate cut stating the time has come for policy to adjust. Powell added that with the inflation backdrop looking better, focus had now shifted from price stability to the state of the labour market. Notably, Powell confirmed the Fed now does not seek or welcome further labour market cooling, a comment which emphasises the importance of the 06 September jobs report.
Whilst there were no comments that suggested preference for a 25bps or 50bps cut on 18 September, Powell's references to a softer labour market imply that he and his FOMC colleagues may opt for a half-point cut should a second soft jobs report follow July's data. Another uptick in the unemployment rate (to 4.4% or 4.5%) in addition to a headline payrolls number within proximity to 100K may induce a larger cut to kick off the easing cycle.
Fed-watchers have been consumed by the 25 vs 50bps debate in recent weeks, with the addition of another critical question entering the debate…..
Where is the neutral rate?
The neutral rate is the policy rate that is neither restrictive nor accommodative, a state by which monetary policy has reached equilibrium.
Calculating, modelling, projecting the neutral rate or r* as its also termed, is a tough gig…..basically its guess work. The Fed thinks its somewhere around 3%.
Rates markets price in 100bps of easing by the end of the year and another 125bps by the end of 2025, dropping the Federal Funds target rate to around 3%.
But, if labour market conditions were to continue to deteriorate as the US economy falls into recession, the Fed likely unleashes closer to 300bps of monetary easing, causing a rethink of where the neutral rate resides.
The neutral rate debate, the pace at which the world's largest economy cools and the magnitude of Fed easing will dictate the direction of the dollar and the majors over the next 18mths.
Shifting our attention back to the present and the path of the New Zealand dollar - the +2.83% week-on-week advance lead the way amongst the G10 cohort and was the second largest weekly gain for the Kiwi in close to 2 years.
Upside hurdles were cleared with ease.
Recalibrating the focus on the topside, technical levels to monitor this week include 0.6258 - the 38.2% (longer-term) Fibonacci retracement of the February 2021 to October 2022 downtrend. North of here, 0.6280 provided resistance in early January whilst December's swing high a pip or so shy of 0.6370 presents as the 12-month high.
Given the lighter economic calendar for the week ahead, expectations are such that NZD/USD upside pauses, replaced by consolidatory price action. On the last three occasions the Kiwi achieved a week-on-week gain of greater than 2%, the following week delivered a pullback.
Given the lively price action through last week, the market may slip into wait-and-see mode ahead of the 06 September jobs report.
Events of note this week include inflation data for Australia (monthly) the eurozone, Tokyo and core PCE in the US. GDP for the US and Canada will be in focus whilst China's NBS PMIs drop over the weekend. The near-term direction for US equity markets will be heavily influenced by Nvidia's earnings results, released after Wednesday's closing bell (Thursday morning). Should investors have doubts regarding the sustainability of the AI darling's lofty valuation, megacap tech likely gets crunched, leading the broader market lower.
Mean reversion could be the state of play this week if Nvidia disappoints, inducing a pullback for risk-sensitive assets, including the New Zealand dollar.
Importers, you're being presented with great levels!
Stuart Talman is Director of Sales at XE. You can contact him here.
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