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The Week Ahead in FX Markets – Kiwi dollar on Santa’s sleigh as the rally continues

Published December 9, 2019

By Phil Lynch

The New Zealand dollar opens at 0.6559 this morning, after climbing a solid 2.2% across the first week of December. This takes the 60-day gains to more than 5%, and see’s the kiwi trading at its highest level in four months. Today we break down what has caused the kiwi to shift higher. But first, we break down key developments from the weekend.

U.S. Employment Situation – Non-farm Payrolls Surprises to Upside

On Friday night, the U.S. Department of Labour released it’s November employment report, which showed a solid 266k new jobs were added to the economy. This took the Unemployment Rate down to 3.5%, whilst Average Earnings rose at 3.1%.

The surprisingly strong data caused U.S. Treasury Yields to rise, and this in turn strengthened the U.S. Dollar against most currencies. However, any gains the USD made against the NZD were short lived – and the NZD continued its grind higher.

Kiwi Breaks Out – What’s the Cause, and What’s Next?

The Cause

The NZD has climbed 3.7% on a trade weighted basis across the last month. There has been little in the way of tier one economic data to justify this market reaction. This has got some people wondering if a Santa rally has come early for the flightless kiwi.

Whilst it is difficult to argue against some of the historical evidence of NZD rallies in the calendar month of December, it is not good enough for me to put the cause down to a man in a red suit. The actual cause of the kiwi rally has been the shift in expectations in domestic interest rates. Just two months ago, markets had priced in 60 basis-points of cuts in the OCR in 2020, whereas now they are pricing in just 10 basis points – not even enough for a single cut, given the RBNZ only moves in cuts of 25 basis-points at a minimum.

The shift in interest rate expectations was caused by the RBNZ surprising markets and keeping the OCR on hold when they met on the 13th of November. This move has been supported by the actions of other central banks including the U.S. Federal Reserve and the Reserve Bank of Australia who have also entered a holding pattern with their rates.

Real interest rates in New Zealand have also climbed. The 2-Year Government Bond Yield has jumped from 0.71% to 1.05%. Whilst this looks like small jump, it represents a 47% increase in yield for the NZD. 10-Year yields have also jumped from a low of 1.0% to current levels of 1.50% in less than two months.

What’s Next?

Markets are now entering a new period, with central banks on pause. This could be a popular, but boring, theme for 2020. It’s entirely possible that the U.S. Federal Reserve and the RBNZ are both on hold with their interest rate settings for the entirety of 2020.

This, however, does not make the central bank announcements irrelevant. It means that markets will have to pay more attention to economic data, to ascertain which direction central banks will eventually head.

Given the lack of interest rate market moves, markets will instead focus on other developments. The most important of these is the trade war. This is the perfect time to look at our Week Ahead.

The Week Ahead

U.S. – China Trade Relations

The trade war between the U.S. and China tends to go in a cycle:

  • The U.S. is tough on trade with China
  • Market sells off on trade war fears (and NZD goes down with it)
  • The U.S. hints at a resolution
  • Market rallies temporarily (and NZD goes up with it)
  • No progress is made – and we’re back to U.S. being tough on trade

We’re at a key point in trade relations. The U.S. is due to place additional tariffs on China on 15 December. But President Trump reportedly likes the direction of trade talks. The market has rallied on the news that the U.S. and China may be close to reaching a resolution.

So will the cycle be broken and a trade deal struck? This would see the NZD continue its rally. Or will Trump resort to being tough on trade? Sending markets back towards uncertainty? Current bets are leaning towards some sort of trade agreement – but Trump is renowned for his unpredictability.

NZ Half-Year Fiscal Update

This Wednesday, the New Zealand Treasury publishes the Half-Year Fiscal Update. A key factor that will play a role in the NZD, will be the fiscal stimulus that the Government injects into the economy. The Labour-led government has (somewhat ironically) been criticised for being so tight with spending, as they have kept the debt to GDP ratio at 20%.

Most now expect the Government to take that debt to GDP ratio to 25%, by borrowing and spending on infrastructure. In theory, this should provide our economy a shot in the arm and should be NZD positive.

The FOMC Rate Decision

This Thursday morning at 8:00 AM the U.S. Federal Open Market Committee will publish their decision on the Fed Funds Target Rate – the equivalent of our OCR. Markets have priced in a 97% chance of rates being kept on hold at 1.50 – 1.75%.

It’s likely this major event will be something of a fizzer, and markets are likely to focus their attention on the possibility of a trade agreement. However, it will be important to get a sense of direction for 2020. Markets are pricing a 25 basis point cut by the end of December – so there is an ever so slight dovish sentiment that may not be justified.

British General Election

On Thursday (or Friday NZ time), Britain once again head to the polls. Prime Minister Boris Johnson is looking to acquire the seats he needs to take Britain out of the EU with his most recent deal. It’s looking promising for Johnson, but we now know not to take election polls for granted. Any hiccups here could see further volatility in global markets.