NZD/USD: Trading the Reserve Bank of New Zealand Interest Rate Decision

Trading the News: Reserve Bank of New Zealand Interest Rate Decision

What’s Expected
Time of release:        12/09/2009 20:00GMT, 15:00 EST
Primary Pair Impact :    NZDUSD
Expected:         2.50%
Previous:         2.50%

Impact the RBNZ Interest Rate Decision has had on NZDUSD through the last 2 meeting

October 2009 RBNZ Interest Rate Decision

The New Zealand central bank kept borrowing costs at the record-low of 2.50% in October and pledged to keep the cash rate at its current level until the second-half of the following year in order to encourage a sustainable recovery. Reserve Bank of New Zealand Governor Alan Bollard stated that there remains “no urgency to begin withdrawing monetary stimulus” as the outlook for growth and inflation remains weak, and went onto say that “the forecast recovery in economic activity is based on fiscal and monetary policy continuing to provide substantial support to the economy” as the marked appreciation in the exchange rate continues to hamper the prospects for an export-led recovery. Moreover, the central bank said business spending remained weak, while credit growth was “very subdued,” and policy makers are likely to hold a dovish outlook for future policy as trade conditions remain far from favorable.

September 2009 RBNZ Interest Rate Decision

The Reserve Bank of New Zealand held the benchmark interest rate at 2.50% for the third month as policy makers anticipate a “patchy recovery,” but held an improved outlook for future growth as the board projects economic activity to expand at an annual pace of 1.3% in 2010 amid an initial forecast for a 0.8% rise in June. The central bank said that “there is more evidence that the decline in economic activity is coming to an end” as policy makers see the $128B emerging from the recession, but went onto say that there “is still sufficient risk and uncertainty around the recovery” to maintain the expansion in monetary policy. Moreover, the RBNZ said that the marked appreciation in the exchange could hamper the prospects for a sustainable recovery, and state that the “recovery will be brought into question” if the currency continues to strengthen going forward.

What To Look For Before The Release

Traders with access to market depth information via the FXCM Active Trader Platform may use it to gauge the potency of the economic data release as well as to shed some light on the market’s directional bias. Increasing volume ahead of the announcement will telegraph likely follow-through behind whatever move is to materialize, while an imbalance in available liquidity on the Bid versus the Offer side of the market will tell us the direction major institutions are likely favoring ahead of the announcement:

Bullish Scenario: If we see substantially deeper available liquidity on the Bid side of the market, this tells us that major price providers in the market are looking to buy the NZD against the US Dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bullish bias on NZDUSD ahead of the data release.

Bearish Scenario: If we see substantially deeper available liquidity on the Offer side of the market, this tells us that major price providers in the market are looking to sell the NZD against the US Dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bearish bias on NZDUSD ahead of the data release.

How To Trade This Event Risk

The Reserve Bank of New Zealand is widely anticipated to hold the benchmark interest rate at 2.50% for the fifth consecutive month in December as the central bank continues to see a risk for a protracted recovery, and the region’s currency is likely to face increased volatility throughout the week as investors weigh the outlook for future policy. A Bloomberg News survey showed all of the 13 economists polled forecast the RBNZ to keep borrowing costs at the record-low going into the following year, while investors are pricing a zero percent chance for a rate hike according to Credit Suisse overnight index swaps as Governor Alan Bollard pledges to hold the cash rate at its current level until the second-half of 2010 in order to stem the downside risks for growth and inflation. Consumer prices in the isle-nation grew at an annual pace of 1.7% in the third-quarter to mark the lowest level of inflation since the first three-months of 2004, while producer prices unexpectedly tumbled 1.4% during the same period, led by a drop in the cost of natural gas. Moreover, food prices in the region tumbled 1.5% in October to mark the biggest decline since March 1993, while wage growth cooled to an annualized pace of 1.9% in the third quarter to post the smallest rise since June 2001, and inflationary pressures are likely to remain subdued over the following year as policy makers expect price growth “to track conformably within the target range over the medium term.” Moreover, a report by Statistics New Zealand showed employment tumbled 0.8% during the three-months through September, which pushed the jobless rate to a nine-year high of 6.5%, while manufacturing expanded at a slower pace in October as the business PMI reading slipped to 50.6 from a revised reading of 51.5 in the previous month. Meanwhile, New Zealand’s Institute for Economic Research urged the central bank to keep borrowing costs at the record-low as the rise in unemployment weighs down on private spending, and argued that “there is more spare capacity in the economy than people realize” as the government stimulus begins to taper off. In addition, the Organization for Economic Cooperation and Development saw a risk that the “recovery could be hampered by the overhang of high private-sector indebtedness, ongoing credit contraction, the currency’s recent strength and rising unemployment,” and went onto say that monetary and fiscal policy should “remain expansionary” over the near-term in order to shore up the real economy.

As the RBNZ is expected to hold the interest rate at 2.50% going into the following year, trading the given event risk could favor a bearish outlook for the New Zealand dollar following the drop in the interest rate outlook but nevertheless, price action following the policy meeting could set the stage for a long kiwi-dollar trade as the economy emerges from the recession. Therefore, if the central bank holds an improved outlook for the economy and reverts to a hawkish policy stance, we will look for a green, five-minute candle following the rate decision to generate a buy entry on two-lots of NZD/USD. Once these conditions are met, we will place the initial stop at the nearby swing low or a reasonable distance taking volatility into account, and this risk will determine our first target. The second objective will be based on discretion, and we will move the stop on the second lot to cost once the first trade reaches its target in order to preserve our profits.

On the other hand, the downturn in the labor market paired with the slump in price growth may lead the RBNZ to hold a dovish outlook for future policy, and comments following the rate decision could weigh on the exchange rate as the central bank continues to see a risk for a protracted recovery. As a result, if Governor Alan Bollard maintains his pledged to keep the interest rate at the record-low throughout the first-half of the following year and holds a cautious outlook for future growth, we will favor a bearish forecast for the New Zealand dollar, and will follow the same setup for a short kiwi-dollar trade as the long position mentioned above, just in reverse.

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To discuss this report contact David Song, Currency Analyst: dsong@fxcm.com