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Analyst Pick: A Cut by the RBNZ is Just What EUR/NZD Needs

Analyst Pick: A Cut by the RBNZ is Just What EUR/NZD Needs

Christopher Vecchio, CFA, Senior Strategist

The Reserve Bank of New Zealand meets tomorrow and traders are engaged in a tug-of-war over what might happen. In aggregate, we can see that rate expectations are split basically 50/50, so about half the market will be wrong tomorrow, cut or no cut (follow the above link for more details on RBNZ rate expectations).

The New Zealand Dollar has been rangebound for the past few months on the back of steady expectations for the December policy meeting; we illustrated the importance of the implied bank rate on the NZD/USD spot price this morning. The logic holds for all NZD-crosses, though: should the RBNZ cut rates, prices across the NZD-spectrum are primed for volatility.

To take advantage of a potential RBNZ rate cut, ideally we'd prefer to stay on the opposite side of the crowd, and likewise, take advantage of near-term shifts in central bank policy expectations.

EUR/NZD may be fertile ground for a bigger move higher. On the sentiment side, we know that the retail crowd is net-short the Euro (via EUR/USD and EUR/JPY), and positioning in the futures market is very one-sided (which increases the susceptibility of the market to short covering). Similarly, the ECB's decision - or lack thereof - to expand its easing measures has proven to be a catalyst to the unwind of carry trade positions, which the New Zealand Dollar is front-and-center to.

Chart 1: EUR/NZD Daily Chart: July 2015 to Present

EUR/NZD daily chart bullish falling wedge

A review of the EUR/NZD daily chart leads us to believe that the market is organizing itself in a 'loose' bullish falling wedge; a 'tighter' pattern would have provided more tests of both support and resistance to give greater legitimacy to the pattern. Nevertheless, risk management is key, and in the event that this bullish falling wedge is the incorrect interpretation, proper risk management is the only tool that will help mitigate future issues. The bullish daily key reversal in price on December 3 yields a solid low point to reference as the absolute level of risk for any bullish EUR/NZD entries eyed.

Ideally, we'd like to see price eclipse the recent swing highs during the downtrend around N$1.6575, in tandem with the daily Slow Stochastics and MACD indicators moving through their respective median/signal lines. The EUR/NZD rally during the summer was confirmed by both Slow Stochastics and MACD holding above their respective median/signal lines; we'll look for a similar development to confirm the potential new wave of bullishness.

TRADE STRATEGY: Long EUR/NZD on Bullish Wedge Break

Entry: 1.6575 or higher

Stop: 1.6075 or lower (-500-pips)

First Target: 1.6950 (+375-pips)

Second Target: 1.7195 (+620-pips)

Third Target: 1.8000 (+1425-pips)

Lastly, as we approach the holidays and thus less liquid markets through the end of the year, it's worth reviewing principles that help protect your capital. We call these principles the "Traits of Successful Traders."

Read more: Tug-of-War in RBNZ Rate Expectations Keeps NZD/USD on Alert

--- Written by Christopher Vecchio, Currency Strategist

To contact Christopher Vecchio, e-mail cvecchio@dailyfx.com

Follow him on Twitter at @CVecchioFX

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DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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