New Zealand Dollar, Equities And Bonds Hold Breathe For RBNZ Decision

How Will The Markets React?

Though tomorrow’s RBNZ monetary policy meeting is expected to yield no change in the nation’s official overnight cash rate, speculation over a possible shift in sentiment has grown markedly. To draw a comparison, December’s ultimate pass after two days of deliberation warranted the same rhetoric Governor Allen Bollard has voiced since the final quarter-point hike a year ago. Up until last month, the data coffers were well stocked with hawkish indicators. Still on third quarter inflation numbers, price growth in the consumer sector was still outside the central bank’s 2-3 percent target band. Furthermore, strong employment trends and accelerating wage growth allowed consumer spending to continue unchecked and threatened to support high inflation despite the downturn in the economy. Fast-forward to today and the landscape has changed. The downward pressure on the economy is still in place as the slowest pace of growth in six years offers the most current read on the economy. However, a few key components have joined the mix. Housing, marked a 12 percent drop in building permits for November. More imperative was the drop in consumer activity. November retail sales contracted for the first time in seven months, offering the first signs of restraint from consumer spending. In the end, the deciding factor may be the recently released fourth quarter CPI data. According to government statistics, price growth contracted for the first time in nearly six years in the fourth quarter, while the annual rate finally pulled back within the RBNZ’s target band. Armed with these conspicuous data points, equity, debt and currency traders will search out any hint of a dovish comment from Bollard.

Bonds – New Zealand 10-Year Treasury Bonds

New Zealand treasuries may be the best positioned asset for a surprise change in RBNZ rhetoric. Over the past two months, government debt traders have pressured ten-year yields higher unfettered by the spat of unfavorable data.  It is the current level in the face of growing event risk that could leverage a volatile move. From recent price action, opposing market forces have announced their presence in the market. After the worse than expected CPI numbers ran across the wires last week, yields were hit with their biggest daily drop since November. Since then, a steady bid has worked its way right back up to the threshold. Resistance is clearly marked at 5.95. However, even if the central bank takes a decidedly dovish turn in its outlook for rate policy, the reaction may be muted. New Zealand debt is highly prized the world around as investors seeks the highest return possible while at the same time having the assurance of the highest available debt rating sovereign governments can obtain.

FX – NZDUSD

The New Zealand dollar has shown relatively little hesitation ahead of tomorrow’s RBNZ interest rate decision, rallying above the psychologically significant 0.7000 mark ahead of the release. Such a marked appreciation ahead of a key fundamental data report highlights the overt optimism on behalf of Kiwi bulls, but underlying risks could threaten such bullishness. The New Zealand dollar has clearly enjoyed the support of the highest interest rates of any country with a top S&P sovereign rating, but prospects of falling interest rates could just as easily strip the currency of such strong yield-based demand. Indeed, this may like what we saw with the previously mighty US dollar. The chart below shows that the Greenback continued to appreciate against the Kiwi through the end of June, but the last of 17 consecutive interest rate hikes effectively spelled the end of strong US dollar demand. The same could arguably happen if the Reserve Bank of New Zealand signals it is unlikely to raise rates further through the end of the year.

Quantitative evidence suggests that it is not only the absolute level of interest rates that impact currency valuations, but the rate of change of those measures are typically the more accurate drivers of overall trends. As such, expectations of potential RBNZ rate cuts through the medium term would easily weaken NZD-denominated pairs. Markets will closely monitor new developments out of tomorrow’s RBNZ commentary, with any hint of dovishness to potentially lead a Kiwi sell-off across major counterparts.

Equities – NZX 50 FF Index

New Zealand equity markets have seen continued strength through 2007, as markets remain resilient to the highest interest rates of any country with a top S&P Sovereign rating. Indeed, the past week of gains clearly leaves the NZX 50 FF Index in somewhat of a vulnerable level at record-highs. It seems that stock traders seem relatively little concerned with the considerable event risk posed by tomorrow’s RBNZ meeting, instead leaving equities higher ahead of the event. All things being equal, this implies that speculators see little danger of the central bank moving interest rates higher through the medium to long run. If, however, the central bank releases comments that are more hawkish than markets predict, we could easily see the NZX 50 pare some of its recent gains.