Why is the New Zealand Dollar steady as oil drives inflation pressures and RBNZ rate hike bets?

• An 80% probability of an RBNZ rate hike reflects surging energy costs, despite expectations of softer Q3 CPI.
• Higher oil prices and geopolitical uncertainty in the Middle East lend support to the US Dollar.
• While markets anticipate a pause next week, Chair Warsh leaves future rate decisions open.

Caution ahead of New Zealand’s Q3 Consumer Price Index (CPI) inflation release is supporting the New Zealand Dollar (NZD), with the data due later on Thursday. Following volatile trading, NZD/USD retains its gains and trades near 0.5690 during Wednesday’s European session.

Any relief from easing inflation could prove temporary, as higher oil prices are expected to accelerate price growth in the final three months of the year and reinforce the case for additional monetary tightening. For Q3, economists forecast annual inflation of 3.8%, down from 4.1% previously, while the quarterly reading is expected to moderate to 0.8% from 1.5% in Q2.

Swap markets have responded by assigning nearly an 80% probability to the Reserve Bank of New Zealand (RBNZ) raising its official interest rate to 3.00% at next week’s policy meeting. RBNZ Chief Economist Paul Conway pointed to higher oil prices and currency movements as sources of upside risk to the Q4 outlook. Although he said the interest-rate trajectory "is most likely up," Conway stressed that the October decision remained "wide open."

Safe-haven buying is helping the US Dollar (USD) remain firm, limiting movement in NZD/USD as rising oil prices intensify concerns over global inflation. Crude advanced while traders weighed conflicting signals on diplomatic engagement between the United States and Iran. Negotiations are still under way, but high-level meetings in Tehran between Pakistan’s army chief, Field Marshal Asim Munir, and senior Iranian leaders weighed on market sentiment. A diplomat participating in the talks with Washington said efforts to resolve the conflict were continuing, while cautioning that reports of a final agreement being imminent were premature.

Attention in financial markets is also turning to the Federal Reserve’s next policy decision. Traders assign an 85% probability to rates remaining unchanged next week and an 88% probability to a December rate hike, according to the CME FedWatch Tool. Fed Chair Kevin Warsh, however, adopted a neutral position, stressing that he does not "prejudge" interest rate decisions. Markets therefore still lack a clear indication of whether the central bank will increase rates or leave them unchanged at its forthcoming October policy meeting.

Why are long-end US Treasury yields easing while the oil rebound leaves the front end steady?

The shift in US rates was largely confined to longer maturities, according to Deutsche Bank analysts, who noted that "10yr Treasury yields also declined by -3.0bps to 5.11%, though 2yr yields (+0.4bps) ended the day little changed as oil prices reversed their decline." While longer-dated yields edged lower, the pattern suggests that oil’s recent recovery has barely altered expectations at the front end.