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

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

Why Is This Event Important:

However, the ongoing weakness in the private sector could lead the Reserve Bank of New Zealand to maintain a cautious outlook for the region, and Governor Alan Bollard may continue to support the economy and hold borrowing costs steady as the record-low in an effort to stem the downside risks for the region.

What’s Expected:
Time of release:        06/09/2010 21:00 GMT, 17:00 EST
Primary Pair Impact :    NZDUSD
Expected:         2.75%
Previous:         2.50%

Will This Be Market Moving (Scenarios):

A Bloomberg News survey shows 13 of the 15 economists polled forecast the RBNZ to hike the cash rate to 2.75% from 2.50% in June as the economy brushes off the recession, while investors are pricing a 68% chance for a 25bp rate hike according to Credit Suisse overnight index swaps as the central bank sees the economy growing “in line with or slightly faster” that its forecast from earlier this year. As the RBNZ holds an improved outlook for the region and shows an increased willingness to withdraw its support for the economy, the RBNZ may see scope to increase borrowing costs throughout the second-half of the year in order to balance the risks for growth and inflation.

The Upside

With the rebound in global trade aiding the economic expansion, the central bank may hold a hawkish outlook for future policy as the recovery gathers pace. Therefore, comments following the rate decision could spark a bullish breakout in the New Zealand dollar if Governor Bollard sees scope to raise the cash rate further going forward, and the exchange rate may continue to push higher over the near-term as interest rate expectations increase.

The Downside

At the same time, the turmoil within the global financial system paired with the ongoing weakness in the lending market could lead Governor Bollard to support the economy for a little bit longer, and dovish rhetoric from the central bank head could certainly weigh on the exchange rate as investors weigh the prospects for monetary policy. If the RBNZ surprises the markets and decides to keep rates on hold, the New Zealand dollar to break below the May lows as interest rate expectations falter.

How To Trade This Event Risk

Expectations for a rate hike favors a bullish outlook for the high-yielding currency, and hawkish rhetoric following the rate decision could pave the way for a long New Zealand dollar trade as the central bank sees the recovery gathering pace throughout the remainder of the year. Therefore, if the RBNZ hikes the cash rate to 2.75% or higher, we will need to see a green, five-minute candle following the release to establish a buy entry on two-lots of NZD/USD. Once these conditions are met, we will set the initial stop at the nearby swing low or a reasonable distance after taking volatility into account, and this risk will generate our first target. The second objective will be based on discretion, and we will move the protective stop on the second lot to cost once the first trade reaches its target in an effort to lock-in our profits.

In contrast, the instability in the global financial system paired with the ongoing weakness in the private sector could lead the central bank to support the economy in June, and cautious language following the rate decision is likely to weigh on the exchange rate as interest rate expectations deteriorate. As a result, if the central bank drops a bombshell and keeps borrowing costs at the record low this month, we will favor a bearish outlook for the New Zealand dollar, and will follow the same setup for a short kiwi-dollar trade as the long position laid out above, just in reverse.

Impact the RBNZ Interest Rate Decision has had on NZD during the previous meeting

April 2010 RBNZ Interest Rate Decision

The Reserve Bank of New Zealand held the benchmark interest rate at 2.50% in April as the “risks to the global outlook remain elevate,” but went onto say that the “economy is recovery broadly as expected” as trade conditions pick up. As a result, Governor Alan Bollard said that the central bank would begin to hike the cash rate “in coming months, provided the economy continues to evolve as projected,” and sees inflation tracking “within the target range over the medium term” as the private sector remains weak. In addition, the central bank head expects the economy “to recovery in line with or slightly faster” than the March projections, and noted that “households remain cautious, with the housing market and household credit growth subdued.” Nevertheless, as the RBNZ expects the recovery “to pick up further through 2010,” the central bank may increase its willingness to raise borrowing costs as growth prospects improve.

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.

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