Macro/FX Watch: Peak Fed rates won’t mean end of USD strength

USD: Soft CPI can mean a rate peak, but not soft landing

The US dollar was sown 1.5% on the soft US CPI report last night, with high-beat FX AUD and NZD leading the gains in the G7. Both headline and core inflation cooled more than expectations. Headline CPI was flat MoM in October, beneath the expected +0.1% and September's +0.4%, while the YoY eased to 3.2% from 3.7%, beneath the 3.3% expected. Core CPI rose 0.2% MoM, softer than the prior and expected 0.3%, while Core YoY rose 4.0%, beneath the prior and expected 4.1%. Gasoline and car prices drove much of the easing, while rents inflation also resumed its downtrend and could add to further disinflation from here. Fed speakers tried to maintain a neutral stance, saying there is more work to be done, but market got further conviction on the peak Fed rate narrative and is now pricing in 100bps of rate cuts next year.

While we agree with the peak Fed rate narrative, it is important to consider what we get from here. After the Fed’s tightening cycle is over, do we get a soft landing in the economy or a recession? The reaction from the different parts of the market yesterday – specifically with regional banks rising 6% and Russell 2000 up 5% - suggests that market is still betting for a soft landing. If that is the case, dollar could continue to be weak. Growth data becomes extremely key from here and today’s retail sales print will be one to watch. Consensus is expecting negative headline retail sales on the back of low gasoline prices and new-car sales. Rising credit card delinquencies have also been pointing towards increasing pullback in consumer spending.

If the market starts to shift towards a recession outcome, dollar could get a safety bid again. Also, worth noting that, a slowdown in US does not in itself mean that US exceptionalism story is running out. If other economies, such as Eurozone or UK, weaken faster than the US especially given their higher reliance on floating interest rates and energy prices, then US easing expectations could continue to stay further out on a relative basis and that will continue to support the USD. This week’s focus however is on Biden-Xi talks, where a conciliatory tone could aggravate dollar weakness. US government shutdown risks remain on the radar, but the passing of the stopgap funding bill in the House keeps risks under check for now.

Market Takeaway: DXY testing 104 handle, break of which opens the door to 200DMA at 103.61 but break of 0.618 retracement at 102.546 may be needed to confirm downtrend. For now, dollar remains a selective buy on dips as soft landing expectations may prove optimistic.

CNH: Stars are aligning for a recovery

The improvement in China’s activity data remains slow, and overshadowed by the weakness in the property sector. October industrial production grew 4.6% YoY from 4.5% previous and expected while retail sales jumped 7.6% YoY from 5.5% in September. However, property investment underwhelmed once again, coming in at -9.3% YoY YTD vs. -9.1% expected.

However, yuan saw a marked recovery on the back of USD weakness and the efforts by Chinese authorities of continuing with firm fixings despite high USD volatility in the last several weeks have finally brought results. PBoC also did an outsized MLF this morning at CNY1450bn hence, huge net MLF injection of CNY600bn. The net injection was the highest in seven years and could mean a lower chance of an imminent RRR cut, given the authorities do not want to see more pressure on the yuan. There was an unconfirmed news report that China plans to provide CNY1trn of low-cost financing for urban village renovation and affordable housing program, which has cheered up market sentiment.

Biden-Xi talks will be in focus today, with expectations of a conciliatory tone despite strategic differences remaining. This could be further yuan positive. USDCNH closed below 100DMA and traded at sub-7.25 levels in Asia. Next key support at 7.2124, 0.618 retracement.

Market Takeaway: PBOC likely to keep a heavy hand to avoid yuan depreciation, but a recovery back to 7.10 will have to wait for Fed rate cuts to arrive.

Antipodeans: NZD breaks higher, AUD could get another boost from jobs data

High beta currencies responded the most to the peak Fed rate narrative getting further traction. NZDUSD broke back above psychological level and 100DMA at 0.60 while AUDUSD rose to 0.65. China’s liquidity measures also added to the support for the antipodeans, and iron ore prices hit $130 for the first time since March on reports of improving steel demand from China. Upside bias has returned in antipodean currencies and could last until global growth concerns start to weigh.

AUD has also been buoyed by recent RBA rate hike, although the language was dovish. But hawkish commentary could pick up again. Q3 wage price index was reported this morning and came in at 4.0% YoY from 3.6% previously, coming in at the peak of RBA’s forecast. Markets are currently pricing in 50% odds of another RBA rate hike with focus now turning to Thursday’s jobs data.

Market Takeaway: Peak rates narrative could drive AUD and NZD higher until global growth concerns start to weigh. NZDUSD could retest early Oct highs of 0.6056 while AUDUSD faces immediate resistance at 0.6524.