After a surprise lockdown stopped policymakers from raising interest rates back in August, the Reserve Bank of New Zealand (RBNZ) is widely expected to make that move on Wednesday at 02:00 GMT. However, the risks surrounding the kiwi seem tilted to the downside as markets have almost fully priced in three rate hikes over the next three meetings, leaving scope for disappointment. In the bigger picture, China risks have also entered the equation.Â
Delayed, not cancelled
When the RBNZ hit pause on its plans to raise rates in August, it made it clear this was only a delay. Since then, incoming data have shown that the economy was incredibly strong heading into the lockdowns and has remained quite resilient throughout this ordeal.
Consumption naturally suffered and the number of people receiving unemployment benefits has risen lately, but the impact has been much smaller compared to the first lockdown last year. Meanwhile, various business and household surveys have been quite stable, suggesting that most economic actors are looking through the shutdowns and towards a full vaccine-enabled reopening. Indeed, many restrictions have been lifted already.
There will always be some damage from a lockdown – that’s inevitable. The question is how much, and in the case of New Zealand it doesn’t look very severe. Inflationary pressures are still intense, the economy was virtually at full employment before this shutdown, and the housing market is so hot the Reserve Bank cannot ignore it anymore.
Asymmetric risks
Therefore, markets are convinced the RBNZ will raise rates next week, pricing in a 90% probability for such action. Another rate increase is almost fully priced in for November, and then another one in February again. This is a really aggressive pricing – it implies the central bank will hike rates at each of its next three meetings without fail.
It very well might, but that’s already baked into the market, so there is scope for disappointment. In other words, the risk-to-reward profile for the kiwi doesn’t seem very attractive here.
If the RBNZ raises rates and says it will do so again soon, that’s already priced in, so any boost to the kiwi could be minor. On the other hand, if the RBNZ hikes rates and doesn’t commit to an immediate follow-up move in November, or if something happens in the meantime that doesn’t allow that to happen, the currency could suffer as short-term yields decline.
This is a classic example of a central bank being priced for perfection, which means the risks surrounding the kiwi are likely asymmetric and tilted to the downside.
Big picture – neutral?
Taking a step back, the picture for the kiwi seems neutral at this stage. On the bright side, the domestic economy looks likely to rebound from the shutdowns with force, commodity prices are elevated, and growing interest rate differentials will likely support the currency over time, especially against low-yielders like the euro and yen.
That said, the kiwi will also have to grapple with the mounting risks around China, which is the nation’s biggest trading partner by far. There are essentially two crises playing out at the same time, with a painful deleveraging in the real estate sector being compounded by widespread power outages that have plagued heavy industry.
The end result might be a sharp slowdown in Chinese economic growth as these issues get ironed out, which would inevitably hit New Zealand through the export channel. A potential game-changer in this sense would be if the Chinese authorities really started to pull on the stimulus levers, but until then, it’s somewhat difficult to be optimistic on the kiwi.
Taking a technical look at kiwi/dollar, initial support to further declines may be found around the 0.6800 handle, a violation of which would turn the focus towards 0.6725.
On the upside, the first major target for the bulls could be the crossroads of the 0.7095 zone and the downward sloping line drawn from the highs of February.
