By Stuart Talman, XE currency strategist
Risk sentiment shifted back to positive through Tuesday’s sessions against the backdrop of light news flow and Thanksgiving week which is traditionally bullish for US stocks.
The three major US indices are up close to one percent, the dollar and US bond yields lower whilst commodities rebounded after recent broad based selling.
The New Zealand dollar has been one of the strongest performing currencies over the past few weeks and again sat near the top of the G10 leader board, outpaced by the Norwegian Krone.
In recent days, markets have been driven by headlines based off two things: Fed-speak and China Covid developments.
Fed officials have been resolutely hawkish, maintaining their stance that there are more hikes to come as inflation remains persistently high.
Risk assets were catapulted higher following the softer-than-expected 10 November US CPI release which many market commentators believed would fuel a fierce year-end rally.
The rally has stalled through the back-end of last week and early this week as surging Covid numbers in China sour the market’s mood.
China reported over 27,000 cases on Monday, nearing the previous record high of 28,973 reported in April when Shanghai’s outbreak forced wide-spread draconian lockdowns.
Guangzhou, the manufacturing hub in the South of China is the epicentre of the current wave, leading authorities to re-introduce expanded testing, the closure of offices and schools and other measures to restrict mobility.
City-wide lockdowns that occurred in Shanghai earlier in the year have not been actioned this time, however 48 major cities are subject to some form of district-level restrictions.
Its estimated that this is affecting close to one fifth of China’s total economic output.
That’s not great news for China-linked assets, including the New Zealand and Australian dollars, the latter underperforming in recent days given its heightened sensitivity to China.
Having started this week near 0.6150, the Kiwi fell below 0.6090 through Monday’s sessions, the declines largely driven by the negative news flow out of China.
Tuesday has delivered a reversal in fortunes, NZDUSD ascending back through 61 US cents, logging overnight highs a few pips above 0.6160.
Having twice peaked just above 62 US cents last week, the upside bias remains as the Kiwi looks to be re-building momentum to challenge the widely followed 200 day moving average, located near 0.6230.
Should price action resume the march higher, breaking through the 200d MA, this could be a significant bullish development for the Kiwi, potentially opening a path to re-test August highs near 0.6470.
A near term key directional move may occur today as the RBNZ announces the ninth hike of this current cycle which commenced in October last year.
During this period, the RBNZ has delivered 325bps of tightening, lifting the OCR to 3.5%.
Today’s decision is shaping up as the most pivotal of this cycle.
Will the RBNZ hike by 75bps or 50bps?
It’s a very close call with both market (OIS and futures) pricing and the majority of polled economists favouring a step-up to the larger increment.
Why would the RBNZ opt for a mega-hike this deep in the cycle when other major central banks have started to or are just about to slow the pace of hikes?
Inflation continues to run hot, the jobs market is historically tight.
In addition to realised inflation, forward looking expectations of inflation are also rising.
This is particularly concerning for central banks.
If people believe that prices will continue to rise in the future, they will demined higher wages. In turn, businesses will boost their prices to accommodate higher wages.
The result is a wage-price spiral that ensures inflation remains elevated for a prolonged period.
Anecdotally we’re starting to see examples of this in the New Zealand economy, a recent example being the 12% wage increase granted by supermarket operator, Countdown.
The RBNZ’s desire to stamp out inflation expectations may be the key factor in opting for a 75bps hike.
There are also sound arguments for sticking with a 7th consecutive half-a-percent move, one being the lag effects of monetary policy and the concentration of fixed rate mortgages for Kiwi homeowners.
Around 90% of mortgages are fixed, meaning households across the country have fixed their repayments near or at the bottom of the easing cycle that maintained a historically low OCR at 0.25% for around 18 months.
Approximately two thirds of these mortgages are due for re-fixing within the next 6 months and will be done so at significantly higher borrowing rates. This will put pressure on households budgets across the nation, leading to a significant softening in demand.
The RBNZ may favour a 50bps hike to avoid overtightening so late in the cycle.
So, what is the likely reaction from the New Zealand dollar?
To put it in simple terms: 75bps hike, the Kiwi extends higher through 62 US cents; 50bps hike, a retreat back near 60 US cents.
Whichever direction NZDUSD heads immediately following the announcement, the RBNZ’s actions are unlikely to have a prolonged directional impact given global factors (the Fed, China-Covid) are the key drivers for the NZD.
NZDAUD will be an interesting cross to monitor given its sensitivity to rates. Should the RBNZ opt for a more conservative hike, we could see some heavy selling and a prominent top form.
In this scenario, NZDAUD likely gets crunched back through 0.91.
Aside from the 2pm decision and Governor Orr’s 3pm presser, its PMI day – preliminary readings of manufacturing and services activity for AUS, the eurozone, UK and US.
FOMC minutes are released 8am tomorrow morning, scoured to determine the current level of Fed hawkishness.....although we’re already well aware of this given the procession of Fed speakers following the fourth consecutive 75bps hike on 03 November.
Having consolidated in ranges over the past few trading days, the next 24 hours may deliver pronounced directional moves......which direction?
Stuart Talman is Director of Sales at XE. You can contact him here.
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