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

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

Christopher Vecchio, CFA, Senior Strategist

Talking Points:

- NZD/USD may be in bear flag in downtrend from July 2014.

- EUR/NZD base solidifying, but needs N$1.6575.

- Read why a Fed rate hike in December may not be bullish for the US Dollar.

The biggest central bank event on the calendar this week is the Reserve Bank of New Zealand rate decision, and it looks like it could spur a big move in the New Zealand Dollar - no matter what the central bank does. Ahead of the meeting, Credit Suisse Overnight Index Swaps are pricing in a 61% chance of a 25-bps rate cut, while 3-month New Zealand government bills are implying only a 46% chance of a rate cut.

These estimations tell us that the market is engaged in a tug-of-war: about half the market sees a cut while the other half sees inaction. Collectively, there is a large contingent of traders on the wrong side of the RBNZ decision, even before it occurs, which means there will likely be a large move on the decision, one way or the other: about half the market engaged in New Zealand rates instruments and the New Zealand Dollar will have to readjust.

Chart 1: NZD/USD Spot versus 3-mo Implied Bank Rate for 12/17/15

NZD/USD spot versus 3-month bill implied bank rate for 12/17/15

To illustrate this point, the above chart shows the relationship between the 3-month bill implied bank rate for December 17, 2015 since June 9, 2015 versus the NZD/USD spot price over the same time frame. This relationship is statistically significant with a six month correlation of +0.81.

Given the estimation that the RBNZ's main bank rate will be at 2.79% on December 17, a 25-bps rate cut tomorrow - from 2.75% to 2.50% - could dislodge the 3-month bill implied bank rate, and thus, the NZD/USD sharply lower. (This bodes well for our other preferred NZD-centric setup, EUR/NZD as first described yesterday.) Accordingly, should the RBNZ not cut rates, a short-term short covering rally seems likely; the NZD/USD downtrend from July 2014 would still be valid so long as price holds below $0.6900.

See the above video for technical considerations in EUR/USD, AUD/USD, USD/JPY, NZD/USD, EUR/NZD, and the USDOLLAR Index.

Read more: As Markets Digest ECB and NFPs, Time to Turn to EUR/NZD & NZD/USD

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."

--- 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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