Currency markets have slipped into wait-and-see mode ahead of the upcoming US CPI report which is likely to deliver more lively action

By Stuart Talman, XE currency strategist

Following a two day rally for risk assets, Tuesday has delivered subdued trading conditions, markets trading in tight ranges ahead of the next round of US CPI data to be released in the early hours of Friday morning.

Commencing this week near 0.6330, the New Zealand dollar was stronger through Monday, peeking back through 64 US cents following a positive response to Friday’s US employment report.

Consolidative price action through Tuesday has constrained NZDUSD in a ~50 point range between 0.6340 and 0.6390.

News flow has been light due to a lack of tier one macroeconomic data, markets focused on a speech given Fed Chair Powell at a central banking event in Stockholm. However, Powell refrained from commenting on US economic conditions or current monetary policy settings, thereby offering no market moving rhetoric.

Powell’s Fed colleagues have also been speaking to start the new week, both Atlanta Fed President Raphael Bostic and San Francisco Fed President Mary Daly maintaining the Fed’s messaging from late 2022 – the target rate will be raised somewhere above 5% and held there for some time.

The base case for the 01 February FOMC meeting is a further slowing of the cycle – a 25 bps hike to follow December’s 50bps hike which followed four consecutive 75 bps hikes.

Market pricing has firmed further in favour of a 0.25% hike to 4.50%-4.75%, assigning close to an 80% probability.

The consensus pick for Thursday’s US CPI release is for a further moderation in core inflation, falling to an annualised rate of 5.7% following a 6% result when November’s reading was released on 13 December.

Core inflation in the US peaked at 6.6% in September.

The focus now for markets is the trajectory of consumer prices, rather than last year’s fixation on the actual peak.

If prices fall steadily throughout the first half of 2023 whilst a modest economic slowdown evolves, US equites and other risk assets could avoid another year of carnage.

However, if inflation remains persistently high, for example core inflation staying above 4%, the Fed will likely prolong the tightening cycle, lifting the terminal rate from current expectations of near 5% to a higher end-point in the 5.50% to 6.00% region......perhaps even higher if, as some market commentators expect, energy prices rally hard throughout 2H as the China economy fully re-opens.

In this scenario, a bullish repricing of the yield curve would cause immense pain for US stocks, delivering fresh cycle lows as the US and other developed economies experience deep and protracted recessions.

The pro-cyclical New Zealand and Australian dollar’s likely to be the worst performing currencies plunging back down into the 0.50’s and low 0.60’s respectively.

Given the uncertainty for the path of inflation this year, there are a wide range of expected outcomes for 2023.

Considered and pro-active currency risk management will be crucial.

Looking to the day ahead the local session delivers ANZ–Roy Morgan Consumer confidence, the survey reporting a sharp deterioration in household sentiment through the latter stages of 2022. This trend is expected to continue as inflation remains high and the RBNZ continues to execute one of the more aggressive central bank tightening cycles.

Regionally, retail sales and the relatively new monthly CPI update for Australia and Chinese CPI are the major data points.

Its shaping up to be very quiet during the offshore sessions – no market moving data points or other events of note.

Expectations are for sleepy price action through the next 24 hours, the Kiwi to remain in the prevailing range and within close proximity to 64 US cents.

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