RBNZ Hikes, NZD Soars, Talk Of More Tightening

RBNZ Hikes, NZD Soars, Talk of More Tightening

As promised, Wednesday’s Reserve Bank of New Zealand monetary policy decision proved to be a big market mover for the New Zealand dollar. NZD rose more than 1 percent against the greenback to its strongest level in 3 weeks on the back of the RBNZ’s 25bp rate hike. Its strength was even more exaggerated against the euro with EUR/NZD falling to its lowest level in more than a year. Investors are piling back into the long NZD trade because not only did the RBNZ tighten, but they said rates will need to return to a more neutral level, which reflects their commitment to additional tightening. The tone of the RBNZ statement was relatively positive with Wheeler saying there’s strong momentum in the economy and signs of inflation. The central bank is making it very clear that the recent decline in commodity prices and pullback in manufacturing activity will not stop them from normalizing monetary policy. Although growth is expected to slow in 2015 the central bank remains on track to bring interest rates up to 4.5% by the end of next year. As for the currency, the RBNZ believes that the dollar will decline with commodity prices and unlike the last meeting when Wheeler threatened to intervene, this time he refrained from commenting, saying only that they will monitor the currency’s value. While the decision to raise rates was widely anticipated by economists surveyed by Bloomberg and the Shadow Banking Committee, most market watchers believed that the Reserve Bank would signal slower rate rises. Since there was nothing of the sort in Wednesday’s statement, NZD should extend higher on the back of the RBNZ’s hawkish monetary policy stance. A move to 87 cents for NZD/USD is likely but stronger gains should be seen versus the euro, Japanese Yen, Canadian and Australia dollars. Stronger consumer confidence also drove AUD higher against the greenback Wednesday. Australian employment numbers were scheduled for release Wednesday evening and given the recent strength of AUD/USD, a very strong report was needed to drive the currency pair above its year-to-date high of 0.9461. If employment growth surprises to the downside, AUD/USD could reverse quickly but after Wednesday’s RBNZ rate decision, a deeper slide could be seen in AUD/NZD.

Dollar Should Have a Muted Reaction to Retail Sales

The U.S. dollar traded lower against all of the major currencies Wednesday with the exception of the euro and Swiss Franc. The pullback in U.S. Treasuries and decline in equities reduced the attractiveness of U.S. assets. The recent consolidation followed by Wednesday’s slide in stocks has many investors fearing that the rally has come to an end. It is too early to tell but tomorrow’s retail sales report will play a big role in the ability of equities to resume their rise. While the dollar may not have a big reaction to the consumer spending report unless it rises or falls by 2% or more, stocks could respond aggressively. Economists are looking for a decent pickup in spending after the modest 0.1% increase in April. Given the improvement in the labor market, we would be surprised if spending growth failed to accelerate. Anything short of 0.3% would be a major disappointment. Unfortunately the risk is to the downside because the pickup in spending reported by Johnson Redbook last month was offset by slower demand reported by the International Council of Shopping Centers. Either way, we expect the dollar’s reaction to be limited because barring +/- 2%, retail sales the data is not expected to have any impact of Fed policy and in turn the market’s appetite for dollars.

EUR Extends Losses, Keep an Eye on Yields

For the fourth consecutive trading session, the euro extended its losses against the U.S. dollar (EUR/USD). Although the decline eased in magnitude, another half-cent move and the currency pair would be trading below the post ECB low and this would confirm that any initial enthusiasm about the positive implications of easing on the currency has faded. No Eurozone economic reports were released Wednesday and the comments from ECB policymakers failed to provide any new insight. According to ECB member Mersch, low interest rates in the Eurozone is induced by low inflation. Dombret felt that the ECB measures were appropriate while Noyer said ECB easing was not enough. He called on governments to take action as well. The zone between 1.3475 and 1.3500 represents a very significant support level for the EUR/USD. EUR/USD traders should keep an eye on European yields. Italian 10-Year yields fell by approximately the same amount as 10-year Treasuries while the drop in German, French and Spanish yields was less, which explains the more modest sell-off in EUR/USD. Eurozone industrial production is scheduled for release on Thursday and a rebound is expected after the decline in March.

GBP: Unemployment Rate Drops to 5 Year Low

Relatively healthy labor market numbers and more specifically the decline in the unemployment rate drove the British pound higher versus the U.S. dollar and euro. EUR/GBP dropped to its lowest level since January 2013 and is now within 20 pips of its 17-month low. Jobless claims fell by 27k in the month of May, driving the unemployment rate from 6.8% down to 6.6%, a 5-year low. While sterling continues to outperform thanks to the improvements in the labor market and the economy overall, without a rise in wage growth, the Bank of England will be in no rush to raise interest rates. Average weekly earnings growth slowed to 0.7% from 1.9% the previous, with earnings excluding bonuses rising by only 0.9% compared to 1.3% the prior month. Considering that the record low in earnings growth was 0.8%, wages are too low to offset any potential increase in inflation. However this will not matter to EUR/GBP because even if wage growth is slow, the gap between U.K. and Eurozone monetary policies is widening and there is no support in the currency pair until 80 cents. As for GBP/USD, the currency pair remains confined in a tight range that we do not expect to be broken by the U.S. retail sales report.

Yen: Saved by MSCI’s Decision on South Korea

The Japanese Yen traded higher against most of the major currencies Wednesday on the back of weakness in U.S. equities. Japan stocks on the other hand performed well overnight thanks to MSCI’s decision to drop South Korea and Taiwan from its list of candidates for developed market status in its reclassification review. This decision leaves Japan as the only developed market in the region that is included in Morgan Stanley’s stock market indexes, which is positive for the Nikkei because it mitigates the risk of reallocation out of Japanese stocks into Korean or Taiwanese equities. Reclassification for South Korea and Taiwan would have been a big deal not just for the Nikkei but also the Yen because trillions of dollars are benchmarked to MSCI indexes. While MSCI noted that South Korea met most of the criteria to be included in the index, very little progress has been made on market accessibility. Tuesday night’s Japanese economic reports were mixed. According to the Quarterly Business Sentiment Index, confidence declined in the second quarter. However any negative implications were negated by the increase in the Domestic CGPI index, a sign that inflationary conditions have improved. Machine orders were scheduled for release Wednesday evening and a pullback was expected after the past month’s sharp rise.

Kathy Lien, Managing Director of FX Strategy for BK Asset Management.