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The Week Ahead in FX Markets – Trade war escalates but NZD holds ground | US data in focus this week

Published August 26, 2019

By Phil Lynch

Markets have had a rough ride over the past 72 hours, with trade wars taking a turn for the worse. China moved to impose tariffs on USD 75 billion of US imports. President Trump responded almost immediately by announcing he would add a further 5% to the tariff on all $550 billion of Chinese imports. Trump later went on to order all US businesses to start looking for an alternative to China.

The New Zealand dollar, however, had shown resilience. The flightless bird had barely moved in reaction to the weekend’s events, indicating that escalations in the trade war are now largely priced into current levels of the NZD. But it was too early to say that the kiwi would be insulated from future developments.

At 10:30 AM this morning when Asian markets started to open, there was an immediate shift lower in the kiwi. The NZD/JPY in particular has shifted 1.8% lower since Friday’s open. This indicates there has been a ‘flight to safety’ event as market participants are heavily buying into the JPY and the USD. It is not completely surprising, given the weekends events.

Jackson Hole Speech – Fed Opening Door to Rate Cuts

Powell’s Jackson Hole speech indicated the committee had mixed opinions about the level of easing that is needed. Whilst the speech was overshadowed by Trump’s comments, the general feeling that Powell opened the door for further cuts when he said the Fed will “act as appropriate to sustain expansion”.

These comments were met by outrage from President Trump who claimed:

“As usual, the Fed did NOTHING! It is incredible that they can “speak” without knowing or asking what I am doing, which will be announced shortly. We have a very strong dollar and a very weak Fed. I will work “brilliantly” with both, the U.S. will do great… my only question is, who is our bigger enemy, Jay Powell or Chairman Xi?”

The Fed is clearly maintaining its independence staunchly but has done enough for markets to fully price in at least a 25 basis point rate cut when the Fed next meets on September 18. In fact, markets are pricing in a 36% chance of a 50 basis point cut. These expectations will be sensitive to economic data, which makes this week’s U.S. GDP, Consumption, and Core PCE Deflator indicators crucial for the kiwi.

RBNZ’s Orr Offers Lifeline

Comments from Governor Orr on Friday afternoon pushed the Kiwi higher as he talked up the local economy.  He described the 50 basis point cut in the OCR as “a pre-emptive double cut” to reduce the need to cut more later.  Orr said the economy was in a very good position, as are the government’s accounts, and the rate cut was designed to get in front of the curve. Orr added that the RBNZ would wait and see before considering another cut and would observe the inflationary impact of this month’s cut before considering further easing. He said the bank would do whatever it takes to support the economy.

Orr did not rule out the possibility of negative interest rates and would keep a close eye on interest rate differentials between economies, watching the US Federal Reserve policy closely. Orr said:

“If other countries are cutting more rapidly and our exchange rate is being forced up, that becomes an issue for us”.