New Zealand Dollar Sold as Decks are Cleared Ahead of RBNZ

The Reserve Bank of New-Zealand (RBNZ) could pre-empt the US Fed and cut interest rates in response to a domestic currency that continues to appreciate back to uncomfortable levels.

After seeing the NZD squeeze sharply higher on Friday expect investors to lighten positions into the rate decision on Wednesday.

Analysts are relatively convinced the bank will cut rates, for a fourth time in ’15; unwinding their previous tightening and taking rates back to post Christchurch earthquake lows.

The market is currently rather more circumspect. With a move less than 50% priced expect RBNZ action to underline a slide back towards 0.6510/20.

Further appreciation by the kiwi following recent data has increased the likelihood the central bank will act as it seeks to devalue its currency in the face of sluggish inflation, falling commodity prices and a slow-down in exports.  

At the close of last week NZD/USD rose – surprisingly - trading against the grain, after the announcement that U.S jobs had increased by 211k in November, a modest but significant 11k above the expected 200k. Normally the data would have been expected to be dollar-positive, but it had the opposite effect against NZD on Friday.

We suspect the higher gold price as being the main culprit for the kiwi dollar rally.

Analysts at TD Bank recently said: “We expect the RBNZ to front-run the U.S. FOMC and cut the cash rate by 25bp to 2.50%, and signal more is possible for 2016.”

The main reason for the move is a drop in inflationary pressures: although inflation rose to 0.4% in September, beating expectations of 0.3%, it was not enough to change the overall view that the economy is stuck in a deflationary rut.

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“We expect that if the RBNZ is serious about inflation targeting via a lower TWI it needs the cut and to lower its bank bill profile for 2016. Inflation is lower for longer as it is. While there has been a run of solid activity data, that has been about volumes, not prices, and we’ve yet to see it develop into sustained inflationary pressure,” added TD Bank.

A continued fall in the price of dairy products, one of the country’s most important exports, which have reached five year lows in November, are further fuelling expectations of a rate cut, in order to weaken the kiwi and provide support for exporters of this crucial national resource. The chart of Milk futures below illustrates the dramatic decline in the commodity.

Dovish case gains renewed impetus

As early as November 17 PoundSterlingLive’s Lisa Sanat was warning of the RBNZ making a cut in December, citing research by ABS Bank which told clients it expected the Reserve Bank to make the cut in-order to boost growth which was forecast to slow dramatically to 2.1% in early 2016, down from 3.0% in early 2015.

"However, a lower NZD and lower interest rates should help lift growth back up to around 2.7% by the first half of 2017,” say analysts who are forecasting the Reserve Bank of New Zealand (RBNZ) to cut interest rates again with an initial cut coming as early as December.

The case seems to have strengthened yet further since then, as the New-Zealand dollar has seen an appreciation against most counterparts.

Given the RBNZ repeated claims that the currency is overvalued the increase in the exchange-rate is further cause for them to lower rates.

At 2.75% they remain attractively high compared to most other G10 countries creating a favourable differential which ensures yet further demand from international carry-traders, looking for the interest rate play, and this has been a contributing factor in the decoupling of NZD from its commodity-rooted fundamentals.   

“Despite business confidence recovering for the third consecutive month in November and strong house price inflation, we expect the RBNZ to lower the Official Cash Rate by 25bp to 2.5% on 10 December,” says ABN Amro’s Roy Teo.

ABN Amro agree with other pro-cut forecasters in that a more accommodative monetary policy and a weaker NZD is needed to cushion the  impact of the weak dairy prices on farmers.

“We expect the NZD to decline to around 0.64 in the coming month as speculative long NZD positions are unwound and the RBNZ step up its intervention in the currency market to weaken the NZD given that the exchange rate is stronger than their forecast,” says Teo.

Barclays meanwhile make shorting the NZ dollar their trade of the week given their economists’ view that the RBNZ is likely to deliver a 25bp cut.

"The market is only pricing in a 40% probability of a 25bp rate cut, and we think the NZD will likely sell off if RBNZ indeed eases. RBNZ may express discomfort with the recent strengthening of the NZD TWI, and could talk down the currency by warning of more rate cuts if the NZD strengthens further," say Barclays.

Despite the proximity of the RBNZ meeting on December 10, investors extended NZD longs for the first week in four according to IMM Positioning data.

Although dairy prices have moderately recovered, falling sales volumes favour a bias towards increasing shorts, especially as markets appear to be under-pricing the risks of a fourth easing in this cycle.