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The Week Ahead in FX Markets – RBNZ Likely to Hold on Wednesday

Published June 24, 2019

By Phil Lynch

The kiwi opens a shade higher this morning but is bracing for a big week of news. Key events ahead include Wednesday’s RBNZ OCR Decision, developments in the outlook for US interest rates, and developments in global markets.

The RBNZ – Timing its Run

This Wednesday the RBNZ will release their next decision on the OCR. With rates at record lows of 1.50%, they are running out of room to keep cutting rates. Yet markets are still pricing in a 32% chance that they will move to lower rates this week.

The challenge the RBNZ has, is like that of the top order of a cricket team in a world cup match. They need to decide how hard and fast they strike. Do they strike quickly and pre-emptively trying to get ahead of the game? Or do they play the long game knowing they can step up the pace down the track? Getting the timing of your run wrong can have a disastrous effect on overall performance – and for this reason I believe the RBNZ will hold rates steady at 1.50% on Wednesday – knowing they can cut rates later this year.

However, the signal is likely to be repeated – that further rate cuts are coming. Most banks continue to forecast an OCR rate at 1.00% or lower by the middle of next year. One bank that has called the OCR outlook pretty well over the last few years is the ANZ. They have recently published their expectations that the RBNZ will cut rates once in November, and once in February. The ANZ have also recently published a research report titled ‘Prospects for Unconventional Monetary Policy in New Zealand’, saying the time to prepare is now “just in case”. In this report they have raised the possibility of having an OCR at -0.25% (yes, minus 0.25%), alongside quantitative easing and other measures. We’re some way off from this yet – but the fact is that the RBNZ’s likely course of rate cuts will leave them with no runway for easing in the event of a larger economic shock.

The Federal Reserve – Your Move

President Trump has been extremely vocal over the past two years, stating repeatedly that the Fed’s 2018 rate hikes caused significant damage to the US economy. Fast forward to the present day, and the Fed now looks on track to cut rates just like the President wants.

Markets are now pricing in a 71% chance of a rate cut from the US Fed when they meet in July, and a 29% chance of a larger 0.50% rate cut. A total of 1.00% in rate cuts is now expected to take place over the coming 12-months – which will no doubt appease the President and support global growth.

A lower Fed Funds Target Rate has traditionally meant a weaker US dollar, and thus supported a higher NZD/USD. On central bank movements alone, the NZD/USD should be well supported. A drop in the Fed Funds Target Rate will also support stronger global growth – which has been weighing heavily on the commodity currencies.

However, there are no longer guarantees that monetary policy alone can be enough to stimulate an economy. There are also genuine concerns that central banks around the world are now entering a rate cutting cycle at a point where interest rates are already at record lows. We are entering uncharted territory when it comes to global monetary policy.

Global Markets

More than a decade on from the GFC and central banks have not even come close to ‘normalising’ their official rates, as had always been the plan. The phrase ‘policy normalisation’ can now be tossed out. Global markets are now entering another period of global monetary policy loosening, as central banks around the world scramble to support slowing economies.

The warning signs are also continuing to rise. It might be the recent inversion of the US yield curve. Or the US-China trade wars. Or political unrest right around the world. Or the recent rise in safe-haven assets like gold (up 10% in the last 30 days). These are also all warning signs for the New Zealand dollar – which does not perform well in times of economic uncertainty. Our currency is the proverbial cork bobbing on the ocean – and there are storm clouds on the horizon.