NZD vulnerable to deeper correction as market focus shifts

Key Movers

Demand for the US dollar accelerated through trade on Monday as markets continue reversing the pre-Christmas sell off amid growing uncertainty surrounding Federal Open Market Committee policy. It seems markets were too quick in embracing disinflationary forces, misjudging the likely timing behind any Fed policy adjustment. Investors had brought forward expectations for a rate cut to as early as March but a string of solid US data sets and cautious FOMC minutes forced a re-adjustment and fading of rate cut hopes. While the US is certainly in the midst of a slowdown, risks activity will pick up ahead of schedule remain in play and we expect the Fed will err on the side of caution when battling inflation, delaying any rate cut until at least June. With the USD on the front foot, the Euro remains increasingly vulnerable to a correction. The single currency has already given up much of the gains won through December and with the global growth outlook unlikely to offer any meaningful improvement through Q1 the Euro could be exposed to further downside risks and a possible move back toward 1.05. In other news earthquakes in Japan and ongoing dovish commentary from Bank of Japan Governor Ueda mean the Yen faces ongoing downside risks. Expectations for an early rate adjustment have been pushed back.
Our attention turns now to key US inflation data. A CPI report on Thursday and PCE inflation release on Friday should provide key insights into ongoing inflation pressures and help shape expectations for Fed policy. We expect a small rise in headline CPI amid rising gasoline prices while core CPI edging lower amid an easing in services lead inflation.