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The Week Ahead in FX Markets – Kiwi Sliding; Busy Week of Data; US Fed to Raise Rates

Published December 17, 2018

By Phil Lynch

The New Zealand dollar opens down more than 1% this morning, having faced heavy losses late last week with risk-sensitive currencies hit hard.

This week, the kiwi faces a busy week of economic data and central bank announcements. This will be coupled with year-end position squaring for large international institutions which often adds to volatility and unpredictability. Before we get into that, it’s worth noting what the RBNZ was talking about on Friday – which kicked the kiwi lower.

RBNZ to Raise Capital Requirements

On Friday afternoon, the RBNZ announced it intends to raise the capital requirements for banks. The big four banks control 88% of the banking system’s assets and this year made a combined net profit after tax of NZD 5,128,000,000 (that’s 5.128 billion). The RBNZ’s proposal is that these banks will be required to almost double the required amount of high-quality capital that they hold, which is expected to chew through as much as 70% of the sector’s profits over five years. This move surprised markets and resulted in the NZDUSD losing 0.5% in a short time.

Risk-Off Sentiment Takes Hold

Markets are growing increasingly sceptical of a successful US trade deal with China, and the kiwi was the biggest loser. Safe-haven currencies like the USD and JPY benefitted at the expense of the kiwi. Weak economic data out of China and Europe also kept the risk-averse mood bubbling along. It is starting to look quite ominous for markets.

How Bad Can it Get?

Both equity and treasury markets have been in decline in late 2018, and this has stoked concerns of a possible recession in the US. In a Reuters poll late last week, economists have estimated there is a 40% chance of a recession in the next two years. The last time a Reuters poll indicated such a high probability of recession was in January 2008 – just eight months before the collapse of Lehman Brothers which fuelled the Global Financial Crisis.

Busy Week of Data – Will the US Fed Come to the Rescue?

US data this week includes Durable Goods, GDP, and Consumption numbers – so we are in for a rocky road with some of this data expected to show some of the cracks emerging in the US economy.

The main event, however, will be the US Federal Reserves decision on interest rates. One of the contributing factors to growth concerns has been the anticipated pace of rate hikes from the US Federal Reserve. For most of 2018, markets have expected 3-4 rate hikes will come in 2019, and that these rate hikes will significantly restrict what has been a blistering pace of growth for the US economy.

Now, markets are expecting fewer rate hikes from the US Federal Reserve – so the Fed has the potential to save the US economy if it pauses its rate tightening cycle and once again adopts an accommodative view. Here is what markets are currently expecting:

  • There is one more hike priced in for 2018, and we will find out for certain on Thursday. Markets are currently pricing in a 76.0% chance of a hike.
  • Reuters polls have a consensus for two further hikes in 2019, but this has come down dramatically.
  • Markets are pricing in an average of 40 basis points of hikes in 2019.

This is a significant shift vs what was anticipated from the US Federal Reserve, and this will make this Thursday’s rate decision crucial for markets. It won’t be what they do that is important, but what they say we should expect in 2019. 

Kiwi Data Front & Centre?

There is plenty to keep local market participants busy this week. This includes a few key pieces of economic data for New Zealand. The releases are kicked off with the ANZ Business Confidence survey on Tuesday. Business Confidence has stabilised at extremely disappointing levels which makes for excellent political fodder. However, this week confidence results will be followed by Q3 GDP data – released on Thursday morning. Markets are expecting a respectable 2.8% growth rate. It is output, rather than opinion, that is a more reliable measure of strength of an economy. A 2.8% growth rate would likely shift the Business Confidence results further into an abyss of unreliability.

At the 2.8% expected rate, we can also expect the RBNZ to maintain their neutral stance on rates with inflation also not facing any real pressure. It is a result that is almost perfectly reflected by the RBNZ’s accommodative long-term stance on interest rates.

Aussie Data Due as NZDAUD Stays Strong

This week the RBA’s Meeting Minutes are published on Tuesday afternoon. Whilst these are not expected to show any significant shift in tone or sentiment, they will always be watched by markets. This release is followed on Thursday with the Unemployment Rate. The NZDAUD has climbed 6.0% from August lows.

Sterling in for a Battle

After another tumultuous week in British politics, markets are now digesting the possibility that the UK leave the EU without a trade deal. The Bank of England has warned of dire potential consequences of such an event, and whilst the impact on the currency of a hard-exit is unknown, the general opinion is for a further 5-10% decline from Sterling in this event.

The Bank of England does not have a lot of scope to ‘come to the rescue’ but will no doubt keep rates firmly on hold when they meet this later this week. There will be a lot for markets to digest this week, with British CPI, Retail Sales and GDP data also due.

Canadian Dollar – Under Pressure

The Canadian Dollar has faced a tough couple of months, with the NZDCAD up 9.3% from its lows in October. This week we will get a clearer picture of how things are going in Canada with the release of CPI, GDP and Retail Sales data.

The Bank of Canada has recently surprised markets by abandoning their more hawkish tone and adopting a more dovish outlook. It is likely the Canadian Dollar will remain under pressure whilst this dovish tone exists, and this week’s data will either support or oppose this stance.

Week Ahead to Return in 2019

This will be our last Week Ahead report for 2018. We will be continuing with our Daily Market Updates for the rest of this week and will return on 7 January 2019.

Quote of the Week – Rudiger Dornbusch

“In economics, things take longer to happen than you think they will, and then they happen faster than you thought they could.”

Perhaps this quote is worth keeping in mind if you are planning any leave over the Christmas break? For now we wish every a Merry Christmas, happy holiday season, and some rest and relaxation!