New Zealand Dollar on Front Foot but RBNZ and Trade Tensions Loom Large

Above: RBNZ Governor Adrian Orr. File Image © Pound Sterling, Still, courtesy of NZ Financial Services Council 

- GBP on back foot, in danger of further loses, amid political upset.

- NZD advances as USD, GBP, retreat but RBNZ now looms large.

- RBNZ financial stability report puts ball back in the NZD's court. 

The Kiwi Dollar advanced against rivals early in the new week but the going could become tougher from Tuesday onward if the Reserve Bank of New Zealand (RBNZ) financial stability report augurs fresh speculation of further interest rate cuts to come, and if U.S.-China trade tensions flare up again.

New Zealand's Dollar has gained a full one percent against the Pound in the last week and more than half a percent against the greenback after the U.S. Dollar softened in response to increasing signs the economy's pulse slowed in the second quarter, while Sterling has suffered in the wake of the latest political upset in London.

Sterling has suffered this week after European parliament election results showed electoral support for the UK's two main parties collapsing in the wake of the Brexit farce that has played out in Westminster during recent months.

"Brexit woes continue to batter the sterling. More recently markets are opening up to the fact that a ‘hard’ Brexit is more likely. As such, the sterling lost some ground on the back of thin trading," says Sandeep Parekh, a strategist at Australia & New Zealand Banking Group (ANZ).

This now threatens to drag the two main parties further away from the so-called centre ground, with Conservative leadership candidates under pressure to support a 'no deal' Brexit and the Labour Party appearing to be eyeing a shift toward naked support for another referendum and remaining in the EU.

Furthermore the pending resignation of Prime Minister Theresa May has created clear scope for a 'hard Brexiteer' to seize control of the government, with the parliamentary leadership contest now the only avenue through which remain-supporting MPs could stop such a thing.That could mean further losses are ahead for the British currency.

Above: Pound-to-New-Zealand-Dollar rate shown at daily intervals.

The outlook for the New Zealand Dollar is finely balanced ahead of Tuesday's Reserve Bank of New Zealand financial stability report, which investors will scrutinise closely for clues about forthcoming interest rate decisions at the bank.

"The release of the Financial Stability Report is unlikely to garner much market reaction but the press conference with Governor Adrian Orr is one to watch," says John Bromhead, another strategist at ANZ.

Analysts widely expect the RBNZ to give the domestic financial system a clean bill of health in its latest review but audience questions in the subsequent press conference could pose a risk to the Kiwi. The report is due out at 10:00 pm, with a press conference following at 12:00 am.

The RBNZ is in the process of deciding whether to double the amount of equity capital domestic banks must hold in reserve, which is something analysts say could eat up around 70% of the sector's profits over a five-year period.

This has prompted speculation that domestic banks could raise their variable mortgage rates in order to offset the impact on their bottom lines, which would have the same effect on households as an RBNZ rate hike.

"The RBNZ's expected decision on raising banks' capital buffers in 3Q19 may also cause concerns about growth and fuel expectations of rate cuts, pushing yield differentials against NZD," warned Hans Redeker, head of FX strategy at Morgan Stanley, in a recent note.

The Reserve Bank of New Zealand already cut its interest rate to a fresh record low this month, in order to stoke inflation pressures that have ebbed further this year in the face of a slowing economy.

That's weighed on the Kiwi Dollar but with the U.S-China trade war also having escalated again this month, analysts are speculating that it could ultimately result in further rate cuts from the RBNZ and more losses for the currency.

Above: NZD/USD rate shown at daily intervals.

"We’re not expecting the RBNZ to ease further at this point, though a turn for the worse in global trade tensions may lead to a revision of that view. We remain neutral on the NZD, with a bias to fade rallies," says Bipan Rai, head of FX strategy at CIBC Capital Markets.

President Donald Trump has lifted from 10% to 25% the tariff charged on $200 bn of imports from China. That was in response to China allegedly backtracking on commitments made earlier in negotiations aimed at addressing its "unfair trade practices".

However, Trump is also now threatening to impose a 25% tariff on all of China's remaining exports to the U.S.. Those clock up to roughly another $300 bn each year. All of this is bad news for the global economy, which suffered in the second half of 2018 after the initial U.S. tariffs were imposed on imports from China.

China has retaliated against President Trump's trade tariffs by lifting levies on around $60 bn of imports from the U.S. to 25% and rhetoric from both sides has increasingly suggested, of late, that each is gearing up for a protracted economic conflict. 

That leaves both Sterling and the New Zealand currency facing downside risks for the days ahead. Pound Sterling Live technical analysis suggests it could be the Kiwi that wins a proverbial tug of war this week, with the Pound-to-New-Zealand-Dollar rate in danger of falling toward first-quarter lows.

However, the Commonwealth Bank of Australia (CBA) team are mindful of the risk that fresh trade tensions could undermine the Antipodean currency's recent gains. 

"NZD/USD will remain under pressure this week. New Zealand’s economy is 28% exports (and Australia’s economy is 22% exports). As a result, both currencies come under pressure when global growth concerns elevate," says Richard Grace, head of FX strategy at CBA.

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