New Zealand Dollar a Sell into RBNZ Meeting says Major FX Trader

- GBP/NZD rises into RBNZ meeting
- NZD could be at risk of 'dovish' surprise
- RBNZ faces headache of rising currency
- NZ's closed borders weigh on the outlook
- How RBNZ keeps yields low is another big question mark

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

The RBNZ meets on Wednesday and one foreign exchange trader says the market is too complacent of a surprise that will send the New Zealand Dollar lower.

The Reserve Bank of New Zealand (RBNZ) meeting comes in the wake of the New Zealand Dollar hitting fresh multi-month and multi-year highs against some of its major partners, namely the Dollar and Euro.

This currency strength will unlikely be welcomed by Governor Adrian Orr and his team who will view it as posing a strong headwind at a difficult time for the economy.

Granted, New Zealand has handled the pandemic well but it has only just started vaccinating its population and it will be months before the country reopens its borders to allow the inflow of tourists and students that its economy heavily relies on.

"The NZ economy has performed well over the past year relative to others but the borders are still closed and will remain that way for some time, which damages potential growth from an immigration and tourism perspective," says a note from the JP Morgan spot currency desk in London.

The RBNZ will therefore likely want to stress it will retain a supportive stance over coming months and will try and fight against rising bond yields (which make for tighter lending conditions) and a strengthening currency.

"We’ll hear from the RBNZ tonight and the risk for me is a dovish surprise, I will be looking to be short NZD into the meeting," says JP Morgan.

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UK Prime Minister Boris Johnson said on Monday that covid-19 was here to stay, a view echoed by England's Chief Medical Officer Chris Whitty.

"Could the world hope to rid itself of the virus?" asks the medical journal Nature. "It’s a beautiful dream but most scientists think it’s improbable."

In January, Nature asked more than 100 immunologists, infectious-disease researchers and virologists working on the coronavirus whether it could be eradicated. Almost 90% of respondents think that the coronavirus will become endemic.

This observation is important: how does a country such as New Zealand, which does not tolerate any cases of covid-19 in the community, shift to accepting that this is an endemic disease that is not going away?

Even with a successful vaccine deployment in New Zealand the covid-19 case load will inevitably rise rapidly once borders are reopened, which could in turn prompt the kind of restrictions much of the major economies are currently under.

Vaccination programmes can never reach the majority of the population, owing to anti-vaxxers and children who are not eligible. Furthermore, a successful vaccination programmes is typically one that keeps patients out of hospital and accepts that vaccines simply cannot stop everyone getting a disease.

New Zealand played the early stages of covid-19 well, but it could find itself struggling in the end game.

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With this in mind, the RBNZ will not be in a position to signal a rosy outlook, which could in turn hurt the NZ Dollar's recent rally.

"I think the market is relatively long NZD as a result and is at risk of a dovish surprise. I don't have short NZD on the books right now because the wind is very much at the head of the USD and I like to play high beta FX from the long side," says a trader at JP Morgan, adding:

"As a tactical trade, I will be looking to get short some NZD either vs USD or on crosses tomorrow evening ahead of the meeting."

The trader observes that the housing market will be another key concern for policy makers, given that new Loan to Value restrictions on mortgages are due bought in to slow down the housing market at the end of March.

"A housing boom was the key pillar of economic resilience in NZ last year and the Labour government don’t seem happy with the widening rich/poor divide in the form of rising housing while the unemployment rate remains above the NAIRU," says the JP Morgan trader.

Cooling the housing boom could mean one of the pillar's of New Zealand's wealth generation is weakened at a time when the rest of the world enters exit velocity from the covid-19 pandemic.

The RBNZ meanwhile has another headache to consider: it might have bought as much government bonds as is permissible, meaning to keep bond yields low and the NZ Dollar where it wants, further exotic measures might be required.

"There is a technicality with their QE programme that is well flagged in the market such that if they were to go up to the limit of bond purchases they have laid out, they will own over the 60% of the bond market that they had sighted as a threshold for RBNZ ownership, beyond which the bond market would become dysfunctional so they will need to reduce that QE programme," says the JP Morgan trader.

He adds the following about how the RBNZ might proceed:

"Whether they address that QE overshoot at this meeting or not remains to be seen but it is a story that is being followed closely in the market so I feel like they will have to.

"Admitting defeat on QE at a time when bond yields are surging higher, resulting in a unfavourably stronger currency at a time when the economy still needs plenty of accommodation wouldn't be consistent with the RBNZ's historical approach and stance on currency weakness.

"Therefore I think if the RBNZ do address the QE situation, they will do so in the form of a pivot from QE to another policy. Rate cuts, forward guidance or foreign asset purchases are all possible alternatives however I have a strong bias for the first 2.

"My base case of a pivot to alternative policy is far from market expectations, which I believe to be RBNZ backing away from QE with no alternative."

* Research provided by FXWatcher.com