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

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 keep the cash rate unchanged for the third consecutive month in December, the statement accompanying the rate decision is likely to spark increased volatility in the exchange rate as investors weigh the prospects for future policy. We are likely to see the central bank maintain a cautious outlook for the region given the ongoing weakness within the private sector, and the central bank may look to retain its wait-and-see approach throughout the beginning of 2011 in an effort to encourage a sustainable recovery.

What’s Expected:

Time of release:12/08/2010 20:00 GMT, 15:00 EST

Primary Pair Impact :NZDUSD

Expected: 3.00%

Previous: 3.00%

Will This Be Market Moving (Scenarios):

A Bloomberg News survey shows all of the 13 economists polled forecast the RBNZ to hold the benchmark interest rate at 3.00% in December, while investors are pricing a zero percent chance for a 25bp rate according to Credit Suisse overnight index swaps as the economic outlook remains clouded with uncertainties. Central bank Governor Alan Bollard may try to talk down the risks for the region after Standard and Poor’s lowered New Zealand’s credit-rating outlook to negative in November, but we are likely to see Mr. Bollard maintain a dovish tone at the policy meeting as he expects the slack within the real economy to bear down on inflation. As the RBNZ lowers its economic assessment for the isle-nation, a further drop in interest rate expectations could lead the NZD/USD to retrace the advance from the previous week, and the exchange rate may trend lower throughout the remainder of the year as policy makers see a risk for a protracted recovery.

The Upside

A report by the New Zealand Statistics showed retail spending unexpectedly jumped 0.7% in the third quarter, with employment increasing 1.0% during the same period to mark the fastest pace of growth since the second-quarter of 2008, and the recent developments could lead the RBNZ to tighten monetary policy further over the coming months as it aims to balance the risks for the region. Accordingly, if the central bank turns increasingly hawkish and sees heightened risks for inflation, we would expect the NZD/USD to pare the sharp decline from the previous month as interest rate expectations gather pace.

The Downside

However, as the housing market remains weak, with inflation expectations holding steady at 2.6% in the fourth-quarter, the central bank may defend its neutral policy stance and see scope to hold the cash rate at 3.00% throughout the beginning of 2011 in order to balance the risks for the region. In turn, the NZD/USD may retrace the sharp rally from the previous week and work its way back towards the 100-Day moving average at 0.7404 to test for near-term support.

How To Trade This Event Risk

Trading the given event risk may not be as clear cut as some of our previous trades as the RBNZ is widely expected to hold borrowing costs at 3.00% for the third time in December, but comments following the rate decision could set the stage for a long New Zealand dollar trade as investors weigh the prospects for future policy. Therefore, if the central bank turns increasingly hawkish and sees an increased risk for inflation, we will need a green, five-minute candle following the statement to establish a buy entry on two-lots of NZD/USD. Once these conditions are fulfilled, we will set the initial stop at the nearby swing low or a reasonable distance from the entry, and this risk will generate our first target. The second objective 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 order to preserve our profits.

On the other hand, the ongoing slack within the real economy paired with the uncertainties surrounding the fundamental outlook may lead the RBNZ adopt an increasingly dovish tone, and the New Zealand dollar may face increased headwinds going into 2011 as the central bank expects to see a tepid recovery. As a result, if Governor Bollard talks down speculation for a rate hike in the beginning of the following year, we will implement the same setup for a short kiwi-dollar trade as the long position laid out above, just in reverse.

Potential Price Targets For The Rate Decision

Impact RBNZ Interest Rate Decision has had over the NZD during the last meeting

October Reserve Bank of New Zealand Rate Decision

The Reserve Bank of New Zealand held the benchmark interest rate at 3.00% for the second consecutive month in October as the worst earthquake in eight decades hampers the outlook for future growth, and the central bank may preserve its wait-and-see approach throughout the remainder of the year as the economic outlook remains clouded with uncertainties. RBNZ Governor Alan Bollard said that the ongoing weakness within the private sector should continue to bear down on inflation even as the government raises taxes on goods and services, but went onto say that further monetary tightening will be “required at some stage” as policy makers expect the economic recovery to carry into 2011. The central bank head also warned that the “recent data has turned out weaker than projected” as the rise in global trade tapers off, and the RBNZ may look to support the real economy throughout the beginning of 2011 as it aims to encourage a sustainable recovery.

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.

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