ForexGen Guide

NZD/USD:

October 2008 Reserve Bank of New Zealand Rate Decision

The RBNZ lowered the benchmark interest rate by 100bp to 6.50% from 7.50% – the largest reduction since the central bank began using the official cash rate in 1999. The extraordinary efforts taken on by Governor Alan Bollard suggests that economic conditions are deteriorating at a rapid pace as the economy slipped into a recession during the first half of the year, and policymakers may ease policy further over the coming months as growth prospects deteriorate. Dr. Bollard stated that ‘economic activity will be further constrained by these international developments,’ and went onto say that the central bank will ‘lower the rate further’ as price pressures alleviate. Falling oil prices have clearly helped to taper the upside risks for inflation, which could lead the RBNZ to hold a dovish outlook throughout the next year.

September 2008 Reserve Bank of New Zealand Rate Decision

The Reserve Bank of New Zealand lowered the benchmark interest rate to 7.50% from 8.00% despite expectations for a 25bp cut. Governor Alan Bollard reduced the cash rate by 50bp for the first time since the 2001 as the economy slipped into a recession during the first half of the year, citing that the bank is now ‘in a loosening mode.’ The downturn in the economy paired with fading demands from the global economy has led the central bank to push inflationary concerns to the backburner even as consumer price inflation reached 5.1% in the third quarter, which is higher than the 4.9% forecast anticipated by the central bank. Despite the uptick in prices, Dr. Bollard expects inflation to moderate over the next few quarters on the back of falling energy prices, and he may continue to hold a dovish outlook as concerns of a global recession intensify.

July 2008 Reserve Bank of New Zealand Rate Decision

The New Zealand central bank reduced its cash rate for the first time in five years by 25bp to 8.00%. The downturn in the housing and financial sector paired with a 0.3% contraction in second quarter GDP continues to fuel recessionary concerns for the economy. RBNZ Governor Alan Bollard stated that ‘economic activity is likely to remain weak over the reminder of 2008,’ and went onto say that the central bank would ‘lower rates further’ if the inflation outlook continues to improve. Dr. Bollard also noted that ‘unpleasant international news has emerged since the June statement and there is a risk that the domestic economy will slow further,’ fueling bearish sentiment for the New Zealand dollar. As a result, the Kiwi plunged after the release, generating a short position with a gain of 25bp.

How To Trade This Event Risk

The New Zealand dollar may face increased selling pressures over the next 24 hours of trading as the RBNZ is widely expected to lower the benchmark interest rate by 150bp to 5.00% from 6.50%. A Bloomberg News survey showed that 10 of the 17 economists polled expect the central bank to lower the key rate to 5.00%, whereas the remaining 7 economists forecast a 100bp cut to 5.50%. The downturn in the global economy paired with weakening demands for exports has clearly taken a toll on firms as business confidence fell to its lowest level in November since recordkeeping began in 1988, and conditions may only get worse as companies continue to scale back on production and employment. The New Zealand manufacturing index contracted for six consecutive months to reach a record low reading of 43.5 from 46.7 in September, while the unemployment rate surged to a five year high of 4.2% from 3.9% in the second quarter. Fading employment opportunities will continue to drag on growth despite the significant fall in energy costs as domestic demands waver. Retail spending fell 0.9% in the third quarter, followed by a 1.4% decline in the previous quarter, and may lead the Reserve Bank of New Zealand to ease policy further as price pressures alleviate. Falling oil prices have certainly helped to taper the upside risks for inflation, which should allow policymakers to hold a dovish outlook going forward. Moreover, RBNZ Governor Alan Bollard stated that he expects economic activity to remain subdued as growth prospects for the global economy deteriorates, and went on to say that ‘we would expect to lower the rate further’ as the outlook for inflation falls within the central bank’s 2% target for inflation. Policymakers expect headline reading for inflation to fall to 2.7% over the next two years as the economy contracts at a record pace, which could lead the reserve bank to ease policy well into the next year as the outlook for growth remains bleak.

Trading the given event risk may not be as clear cut as some of our other trades as market participants expect the RBNZ to aggressively lower borrowing costs over the near-term, so we would need to see a drastic shift in policy to consider a bullish outlook for the Australian dollar. Therefore, a rate reduction of less than 100bp paired with a neutral outlook for future policy would set the stage for a long NZDUSD trade, and we will look for a green, five minute candle following the release to confirm a long trade on two lots of the kiwi-dollar. Our initial stop will be placed at the nearby swing low (or reasonable distance), and this risk will determine our first target. Our second target will be based purely on discretion, and in order to preserve our profits, we will move the stop on the second lot to breakeven once the first trade reaches its target.

Nevertheless, deteriorating fundamentals paired with the drastic slowdown in the economy is likely to push the RBNZ to loosen monetary policy even further in order to ward off the downside risks to growth, and may continue to lower borrowing costs next year as the economy faces its worst recession in nearly a decade. As a result, dovish commentary following a 150+bp rate cut would favor a bearish outlook for the kiwi-dollar, and we will follow the same strategy as the long positions described above, just in reverse.

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