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New Zealand Dollar Braces for Risk Trends and US CPI

New Zealand Dollar Fundamental Forecast: Bearish

Talking Points:

  • New Zealand Dollar declined as the S&P 500 fell, RBNZ cooled rate hike expectations
  • The Fed is on path to overtake RBNZ on rates, diminishing Kiwi Dollar’s yield appeal
  • Heightened inflation fears will have the markets anxiously or eagerly awaiting US CPI

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The sentiment-sensitive New Zealand Dollar came under fire last week as inflation fears triggered aggressive risk aversion in the markets. The 10-year and 30-year US government bond auctions saw less demand, with bid-to-cover ratios falling and yields rose. By Thursday, the S&P 500 corrected lower more than 10 percent from the January 26th high.

Earlier in the week, an impressivelocal employment report initially boosted the currency. In fact, the unemployment rate ticked down to its lowest since the 2007-08 Global Financial Crisis. However, continued volatility in stock markets as well as the RBNZ rate decision soon spoiled the Kiwi’s fun.

The Reserve Bank of New Zealand left rates unchanged and cooled hawkish policy expectations. Overnight index swaps were pricing in a 62.2% chance of a 25 basis point uptick by the end of the year prior to the event. Expectations dropped to 53.5% the day after. Moreover, it became clear that the Fed is likely to overtake the RBNZ in terms of where rates are going in the near-term.

This spells disaster for the New Zealand Dollar’s yield advantage over the US Dollar and brings us to what next week has in store for the markets. On Wednesday, we will get the United States CPI report for the same month as the better-than-expected NFPs outcome. Economists are predicting the headline inflation rate to fall to 1.9% y/y from 2.1%.

However, data out of the country has increasingly outperformed relative to estimates as of late. If this holds true for the US CPI release, it might further firm Fed rate hike expectations. This might in turn lessen the appeal of the New Zealand Dollar, which currently boasts the highest yield in the FX majors spectrum, and make its US counterpart more attractive.

In fact, commentary from the Reserve Bank of New Zealand seemed to align with this argument. Assistant Governor John McDermott pointed out on Thursday that he expects Kiwi Dollar to ease as the Fed raises rates. Meanwhile, Governor Grant Spencer revealed that he was surprised with their low inflation outcome.

A lack of key economic event risk out of New Zealand next week will probably leave Kiwi traders anxiously or eagerly awaiting the US inflation report. With that in mind, the outlook for the New Zealand Dollar will be bearish as it could still be vulnerable to risk trends and diminishing yield appeal.