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The Week Ahead in FX Markets – Central banks all on pause – what next for the NZD?

Published November 18, 2019

By Phil Lynch

It was a busy week in financial markets, and the New Zealand dollar opens 1.1% higher from last week’s opening level. The main event, of course, was the RBNZ surprising markets with a ‘no-cut’ decision. The RBNZ has now moved into a holding pattern – joining the RBA and the Federal Reserve in the ‘wait and see’ approach.

The surprise move from the RBNZ caught all major New Zealand banks off guard – with our top five local banks all expecting a cut (Westpac had predicted no-cut, but changed their view to a ‘cut’ within 48 hours of the decision).

Markets had been pricing in significant further easing for OCR in 2020, but interest rate futures are now showing just a 30% chance of a cut to 0.75% when the central bank next meets in February.

Perhaps the most surprising outcome, is that the New Zealand dollar hasn’t moved higher. At current levels, the NZD/USD is still 1.0% behind it’s November highs. Given the change in stance from the RBNZ, it is reasonable to expect some further appreciation for the kiwi.

Central Bank Interest Rates – Where to Next?

One of the key themes for 2019 has been central banks lowering their base rates, particularly for New Zealand, Australia, and the United States. As we near the end of 2019, we are entering a new phase where each of these central banks have indicated a pause to their rate cutting cycle (or ‘mid-cycle adjustment’, as some have called it).

Each of the central banks mentioned has cut rates by 0.75% so far in 2019, but it’s unlikely we’ll see any further moves this year, or next.

  • The RBA has the highest chance of another rate cut (at 31% when they next meet on 3 Dec). This is largely thanks to the volatile Unemployment Rate – which jumped to 5.3% last week
  • The U.S. Federal Reserve has the most room to cut rates, with their range at 1.50 – 1.75%. But the Fed tends to avoid cutting rates in an election year (I.e. 2020)
  • The RBNZ’s next rate decision is not until February, and markets are no longer expecting further rate cuts

All in all – with all three central banks on hold, we’re likely to see a moderated reaction to interest rate decisions over the coming 12-18 months. But there are other factors at play. Despite equal cuts to the base rates in 2019, the U.S. Dollar Index has climbed 2.3% whilst he New Zealand dollar index across the same period has fallen 4.8%. So what is driving the relative weakness in the NZD?

The Relative Weakness in the New Zealand Dollar

One can be forgiven for thinking the NZD should have performed better this year. Afterall, our economy is performing well. We have reasonable GDP growth, a near record low Unemployment Rate, low and stable Inflation, record low interest rates, a low New Zealand dollar, and strong export commodity prices. And our central bank has given us a 0.75% buffer, which is equal to that of our peers in Australia and U.S. So why has the kiwi been hit so hard?

I can tell you it is not because of the woeful business confidence numbers, which are merely a reflection of the government policies of the day. The relatively weak New Zealand dollar can be blamed on risk sentiment, as evidenced by flows into safe-haven currencies in what has been a rocky year for global markets. There has been good reason for concern, with major global events to consider:

  • Talk of an impending recession, with fore-warnings like the yield-curve inversion in August.
  • Brexit uncertainty, which is ongoing
  • Populism and protectionism taking hold in global politics
  • And of course, the trade wars

These are the major events that will drive currency flows in the coming months. A lot of uncertainty surrounding these events have already been priced into markets – and this is why the kiwi is relatively weak.

The Week Ahead

The coming week is lighter on data, and as such markets will focus on trade war developments. A call is scheduled for Friday night (Washington time), where Treasury Secretary Steven Mnuchin and Chinese Vice Premier Liu He will attempt to come to some sort of an agreement for ‘Phase-One’. Beijing is insisting that tariffs need to be rolled back as part of any phase-one deal, but President Trump is yet to agree to remove any tariffs. A good outcome here will likely see the risk sensitive currencies like the NZD make solid gains.

Worth watching this week, will be releases from central bank meetings from the RBA, the U.S. Fed, and the ECB.  All of these will be worth a look to ascertain just how ‘on hold’ they are with their current rate settings.