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NZDUSD the perfect storm

Promoted by City Index.

Last week we outlined a view for a move higher in the AUDNZD exchange rate. At the time of writing AUDNZD was trading at 1.0940, some 200 pips below where it sits currently. While the direction of the move was anticipated, the speed of the move was unexpected and a pleasant surprise.

The catalyst for the move was the RBNZ delivering a dovish surprise to markets at its 9th of August Monetary Policy meeting. As expected, the Official Cash Rate was kept on hold at 1.75%. However, the RBNZ pushed back the start of rate hikes from Q1 2020 to Q4 2020, citing weaker growth and declining business confidence. The “risks to the growth outlook are tilted to the downside”. The RBNZ also indicated a willingness to look through the current uptick in headline inflation to support slowing growth.

Currency and interest rate markets were quick to reprice with the NZDUSD falling from .6740 to be holding just above .6600c at the time of writing and the 2-year swap rate dropped by 7bps from 2.11% to 2.04%. While there may be a temptation for bargain hunters to take advantage of the cheaper NZDUSD exchange rate we would argue against this strategy, particularly when taking into account the U.S. Dollar side of the exchange rate equation and comments overnight from the Federal Reserve Bank President Charles Evans.

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it is important to point out that while Evans is currently a non-voter on the interest rate setting FOMC, he has been reliably dovish in recent years, arguing that the FOMC should not raise rates until inflation reached 2%. Hence, his hawkish comments overnight stating that the U.S. economy is performing “very well” and with inflation now back to 2%, raising interest rates to “somewhat restrictive” levels are noteworthy.

The level of neutral interest rates in the U.S. is estimated to be about 2.50%, therefore a “somewhat restrictive” level is probably closer to 3.00%. In contrast, interest rates in New Zealand as mentioned above are expected to stay on hold at 1.75% until Q4 2020. Interest rate differentials are a key driver of currency markets (as viewed in the chart below) and are expected to continue to weigh on the NZDUSD.

Also continuing to weigh on the NZDUSD are the results of the latest Global Dairy Trade auction held earlier this week. Dairy products are New Zealand’s largest export and have fallen 9% over the last 5 months. Escalating U.S. – China trade tensions and the falling Yuan are behind the slump in prices, impacting Chinese purchasing power and lowering demand.

From a technical point of view, yesterday’s fall in the NZUSD has confirmed the break of long term trendline support dating back to the 2008 .4891, low as well as the neckline of a potential head and shoulders top. For those familiar with Elliott Wave analysis, the NZDUSD looks to have begun a Wave 3 lower targeting the next layer of medium term support just ahead of the 2015 .6197 low.

To trade this longer-term view, I will be looking to short the NZDUSD on bounces back to .6680 with a stop loss placed above .6850. The target in the medium term is a retest of .6197, however before that support is viewed at .6350.

Source Tradingview. The figures stated are as of the 10th of August 2018.  Past performance is not a reliable indicator of future performance.  This report does not contain and is not to be taken as containing any financial product advice or financial product recommendation

 

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NZDUSD the perfect storm
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