Speculation - Why the New Zealand Dollar Drop on an RBNZ Hawkish Turn
- The RBNZ held its benchmark lending rate unchanged, but the Governor's statement took a decisive change in tack
- Governor Wheeler said the central bank had dropped its dovish bias and expected a hike within two years
- Speculation had set expectations of a hike far earlier, altering the reaction to a sharp Kiwi drop
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Markets don't respond to fundamental developments using textbook interpretations. Speculation leverages, curbs and generally distorts price action's reaction to key event risk and developments. Typically, the alteration anticipation affords is relatively modest. Expectations don't often deviate aggressively from the most probable outcomes. However, there are times when speculation far over-reaches or the data/event itself presents an exceptional surprise. For the Reserve Bank of New Zealand (RBNZ) rate decision this morning, we witnessed the former. And, the reaction from the Kiwi proved severe.
New Zealand's central bank is prone to sudden changes in policy bearing with little warning. The RBNZ in fact committed to a hawkish turn a few years ago - well before any other group started its initial hawkish phase - but decided to reverse course when fundamental conditions and the currency forced it to revert to the international, dovish standard. It is that willingness to commit to significant change that had perhaps built the market's expectations that another dramatic change in tack was soon at hand. Overnight swaps have in fact showed the market pricing in a rate hike within a 12 month period since soon after the November rate decision (at which the RBNZ cut rates). Speculation set the bar, and the central bank had to decide whether it was going to miss, meet or beat it.
Perhaps RBNZ Governor Wheeler was aware of the market's aggressive views - he did mention it in his commentary following the Thursday decision. While the actual policy decision was to keep rates unchanged, the central bank head issued a decidedly hawkish view. He said dovish bias that had guided cuts as recently as the previous meeting in November would be abandoned and that a rate hike would be likely in the next two years. Though this is a hawkish lean in a world of doves, the market was anticipating more. Beyond the remarkable buoyancy of the New Zealand Dollar over the past months, overnight swaps were fully pricing in a rate hike sometime in 2017. In turn, this otherwise remarkable turn disappointed. Speculation changes the fabric of the market and our strategy. We use this extreme example to illustrate a truism in the markets and trading in today's Strategy Video.
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