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

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

2010-07-27 19:15:00
David Song, Currency Strategist
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Trading the News: Reserve Bank of New Zealand Interest Rate Decision

Why Is This Event Important:

As the Reserve Bank of New Zealand is widely expected to increase borrowing costs for the second consecutive month in July, the NZD/USD may continue to trend higher over the week as investors speculate the central bank to normalize policy throughout the second-half of the year. However, Governor Alan Bollard may adopt a neutral tone as the marked expansion in the global economy tapers off, and comments following the rate decision is likely to spark increased volatility in the exchange rate as investors weigh the prospects for future policy.

What’s Expected:

Time of release:07/28/2010 21:00 GMT, 17:00 ESTPrimary Pair Impact :NZDUSD

Expected: 3.00%

Previous: 2.75%

Will This Be Market Moving (Scenarios):

A Bloomberg News survey shows all of the 14 economists polled forecast the RBNZ to raise the benchmark interest rate to 3.00% this month from 2.75% following the hawkish remarks in June, while investors are pricing a 98% chance for a 25bp rate hike according to Credit Suisse overnight index swaps. As the economic recovery in the isle-nation gathers pace, the central bank may see scope to increase the interest rate further over the coming months, and may continue to raise its economic assessment as the region benefits from the rebound in global trade.

The Upside

As the RBNZ anticipate price pressures to accelerate over the coming months and forecasts CPI growth to peak at a high of 5.3% in the year ending June 2011, the central bank may take surprise the market with the 50bp rate hike in an effort to curb the risks for inflation. At the same time, Governor Bollard may hold a highly hawkish outlook for future policy after delivering a 25bp rate hike, and the comments could drive the NZD/USD above 0.7400 as it continues to retrace the decline from earlier this year.

The Downside

However, as the headline reading for inflation falls back to 1.8% in the second quarter from 2.0% during the first three-months of the year, the central bank may hold borrowing costs steady at 2.75% as the outlook for future growth remains clouded with uncertainty. Accordingly, a neutral policy statement following the rate decision is likely to weigh on the exchange rate, which could trigger a selloff and lead the kiwi-dollar to pare the near-term advance from the previous week.

How To Trade This Event Risk

Expectations for a rate hike clearly favors a bullish outlook for the high-yielding currency, and price action following the policy meeting could set the stage for a long New Zealand dollar trade as the central bank holds an improved outlook for the region. Therefore, if the RBNZ raises the benchmark interest rate to 3.00% or higher and holds a cautious outlook for future policy, we will need a green, five-minute candle following the event to confirm 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 market volatility into account, and this risk will establish our first objective. The second target will be based on discretion, and we will move the stop on the second lot to cost once the first trade reaches its mark in an effort to lock-in our profits.

On the other hand, the uncertainties surrounding the global outlook paired with the weakness in the global financial system may lead the RBNZ to adopt a wait-and-see approach, and Governor Bollard may hold a neutral outlook for future policy in order to balance the downside risks for the region. As a result, if the central bank surprises the market and holds the cast rate steady at 2.75%, we will favor a bearish outlook for the commodity currency, and will implement the same setup for a short kiwi-dollar trade as the long position mentioned above, just in reverse.

Further Rate Hikes Ahead -Stronger Than ExpectationsRBNZ Surprises MarketLower Than Expectations

Governor Bollard turns increasingly hawkish as the economic recovery gathers pace.

RBNZ holds rates steady in an effort to curb the downside risks for the economy.

TTN_10-07-27_body_ScreenShot001.png, NZD/USD: Trading the Reserve Bank of New Zealand Interest Rate DecisionTTN_10-07-27_body_ScreenShot001_1.png, NZD/USD: Trading the Reserve Bank of New Zealand Interest Rate Decision

Impact Reserve Bank of New Zealand Interest Rate Decision has had over the NZD during the past month

Period

Data Released

Estimate

Actual

Pips Change

(1 Hour post event )

Pips Change

(End of Day post event)

Jun 2010

06/09/2010 21:00 GMT

2.75%

2.50%

+44

+197

June 2010 RBNZ Interest Rate Decision

The Reserve Bank of New Zealand raised the benchmark interest rate by 25bp to 2.75% in June, which marked the first rate hike in three-years, and the central bank may see scope to normalize monetary policy further in the second-half of the year as the economic recovery picks up pace. RBNZ Governor Alan Bollard held a hawkish outlook for future policy and said “underlying inflationary pressures are expected to increase” as the economy benefits from the rebound in global trade, and pledged to “gradually remove policy stimulus” in an effort to balance the risks for growth and inflation. However, the central bank went onto say “further removal of stimulus will be reviewed in light of economic and financial market development” as the outlook remains clouded with uncertainties, and expects price growth to “track within the target range even as the economy expands further” as the board forecasts inflation to peak at 5.3% in the year ending June 2011.

The sharp decline following the release would have led to 50 points in profit.

TTN_10-07-27_body_ScreenShot003.png, NZD/USD: Trading the Reserve Bank of New Zealand Interest Rate Decision

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.

TTN_10-07-27_body_AT_bull_1.png, NZD/USD: Trading the Reserve Bank of New Zealand Interest Rate DecisionTTN_10-07-27_body_AT_bear_1.png, NZD/USD: Trading the Reserve Bank of New Zealand Interest Rate Decision

Questions? Comments? Join us in the DailyFX Forum

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

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

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