New Zealand Dollar Gains Fade as Fed Overshadows RBNZ Shift into Slow Lane

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

- NZD boosted by RBNZ hint of a pause before cutting again.

- But gains fade after retail sales miss, as Fed's Powell looms.

- Analysts eye October for next RBNZ cut, USD strength Friday.

- Powell speech in risks driving USD higher and the NZD lower.

The New Zealand Dollar was easing lower in late morning trading Friday as a looming speech from Federal Reserve (Fed) Chairman Jerome Powell overshadowed hints of a shift into a more patient interest rate stance by Reserve Bank of New Zealand (RBNZ) Governor Adrian Orr.

Governor Orr said overnight the RBNZ wants to wait a while before making another change to New Zealand interest rates, in part because the bank wants to observe the impact that an earlier three cuts to the cash rate are having on the economy. The RBNZ has reduced the cash rate from 1.75% to 1% this year in the hope of lifting inflation above the midpoint of the 1%-to-3% target by stimulating the economy with lower borrowing costs. 

Despite the RBNZ's significant action to date, financial markets have been betting the bank would cut Kiwi borrowing costs on one more occasion before the year is out, leaving the cash rate at 0.75%. And in no small measure, markets still are looking for another cut but Orr's suggestion the bank could wait a while helped the New Zealand Dollar higher overnight nonetheless. 

"NZD outperformed most major currencies overnight. Not so dovish comments from RBNZ Governor Adrian Orr more than offset New Zealand’s disappointing Q2 retail sales report. Orr said the RBNZ could afford to be patient in assessing the next interest rate move and unconventional policy is far from the RBNZ’s central scenario. Meanwhile, New Zealand Q2 retail sales volumes expanded by just 0.2%/qtr," says Elias Haddad at Commonwealth Bank of Australia. 

Above: NZD/USD rate shown at hourly intervals alongside GBP/NZD rate (black line, left axis).

New Zealand's Dollar rose in response to the RBNZ comments but quickly entered into retreat after retail sales figures showed the high street struggling amid lacklustre spending growth during the second quarter. Sales were up just 0.2% when markets were looking for a 0.3% increase, which speaks to why markets still expect the RBNZ to cut rates again before long. New Zealand's economy is slowing and the outlook for global growth has deteriorated of late, further undermining Kiwi inflation pressures. 

"RBNZ’s Orr pulls the handbrake on dovish expectations for future cuts. He seemingly wants to preserve some optionality as he said overnight that “We can afford to watch, wait and observe what is happening”. This frustrates AUDNZD progress higher," says John Hardy, chief FX strategist at Saxo Bank. 

Changes in rates are normally made in relation to the outlook for inflation, which is sensitive to economic growth, but impact currencies because of the influence they have over capital flows and decisions of short-term speculators. Capital flows tend to move in the direction of the most advantageous or improving returns, with a threat of lower rates normally seeing investors driven out of and deterred away from a currency. Rising rates have the opposite effect.

"The RBNZ will be hoping for signs that the 50bps of OCR cuts in August will be the catalyst to boost domestic demand. We are looking to signs of a rate-cut boost in business and consumer sentiment. If these do not emerge, and growth momentum remains weak, the OCR will move lower. We expect a further 25bp cut in November," says Mark Smith at ASB Bank. 

Another factor driving the New Zealand Dollar lower on Friday was a strong U.S. rival, which has been bid higher as investors increasingly anticipate that Fed Chair Powell's 15:00 speech at a central banking conference will do little to vindicate financial markets for having already bet heavily the U.S. central bank will cut its interest rate as many as three times before the year is out.

Above: Dollar Index shown at daily intervals and annotated for recent events.

"Markets are expecting another 50bps of Fed rate cuts by the end of the year. Even though we expect a dovish overall message from Chair Powell, it will likely fall short of the capitulation demanded by the market," says Lee Hardman, an analyst at MUFG. "The US dollar has been looking to break and stay above the 98.400 DXY level over the past week. It may get its opportunity today." 

The Fed already cut its cash rate 25 basis points to 2.25% in July but is under pressure from President Donald Trump and the markets to do more after the U.S. bond 'yield curve' began signalling last week that a recession is ahead, and as fears mount over the impact the latest escalation in the U.S.-China trade war might have on an already-weak global economy. Neither of those are supportive of the Kiwi, which wouldn't get any support from a reluctance by the Fed to indulge market pricing either. 

"Market participants will be watching the symposium for any signals of the Fed’s thinking ahead of the 19 September FOMC meeting, especially after the chorus of (albeit more hawkish) Fed members yesterday who sounded reluctant to cut interest rates further.  We continue to expect the FOMC to cut interest rates by a further 25bp in September," says CBA's Haddad.

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