New Zealand Dollar loses ground as inflation eases in third quarter

• NZD/USD struggles to extend its recent gains as softer New Zealand inflation data weighs on the Kiwi.
• Falling US Treasury yields and a weaker US Dollar help limit the pair's losses.
• Traders await next week's Fed and RBNZ decisions for fresh monetary policy signals.

NZD/USD pauses a five-day winning streak on Thursday following softer-than-expected domestic inflation data. However, the pair lacks follow-through selling as the US Dollar (USD) remains on the back foot amid declining US Treasury yields. At the time of writing, NZD/USD trades around 0.5686, easing from a one-month high of 0.5711 touched during Asian trading hours.

US Treasury yields fall across the curve, extending their pullback from multi-year highs as concerns over AI-related investments drive demand for government bonds. The benchmark 10-year US Treasury yield slips below 5.00% after reaching 5.36% earlier this month, down around 15 basis points (bps) on the day. Meanwhile, the US Dollar Index (DXY), which tracks the Greenback's value against a basket of six major currencies, trades around 101.60 after touching a three-week low of 101.45.

The AI-related equity sell-off could complicate the Federal Reserve's (Fed) interest rate outlook, even as inflation risks remain tilted to the upside, particularly due to higher energy prices amid tensions in the Middle East.

Traders now look ahead to next week's Fed meeting, where the US central bank is widely expected to leave interest rates unchanged. However, expectations of another rate hike in December have eased, with the CME FedWatch Tool placing the odds at 67.6%, down from around 89% earlier in the day.

In New Zealand, inflation cooled more than expected in the third quarter. Consumer Price Index (CPI) rose 0.7% QoQ, below forecasts of 0.8% and the previous reading of 1.5%. On an annual basis, inflation eased to 3.7% from 4.1%, also missing market expectations of 3.8%.

Strategists at Brown Brothers Harriman observe that, despite the softer headline reading, "underlying inflation points to persistent price pressure." They highlight that "the RBNZ sector factor model printed at 2.8% y/y for a second straight quarter, near the top of its 1-3% target range," while "CPI ex. petrol remained at 3.2% y/y for a fourth consecutive quarter."

Against this backdrop, BBH argues that "above target inflation and still elevated oil prices argue for additional RBNZ rate hikes." They point out that "the swaps curve price in 85% odds of a 25bps RBNZ rate hike to 3.00% on October 28 and more than 100bps of tightening over the next twelve months to 3.75% - near the upper end of the RBNZ’s estimated neutral range of 2.20%-4.10%." Nonetheless, they caution that "NZD/USD upside is constrained because Fed tightening curbs the scope for policy convergence."