RBNZ Bulls Not Affected By Dairy Prices

Capital markets require rate divergence for sustainable volatility, which in turn drives greater investor interest, more volatility and so on. The market just wants price movement. To date, central banks and option traders have been successful handcuffing the forex asset class to tight, contained, and boring currency ranges for many months. Even geopolitical risk, when considered on a grand scale, has had a minimal impact on the market’s twin problems of volatility and volume. Intraday volatility has appeared — last week’s tragic events over the Ukraine combined with the Gaza conflict saw the VIX (everyone’s fear gauge) jump +32% intraday to +14.5. This was the 22nd highest jump ever recorded. However, the fallout from today’s geopolitical and historical events is short lived in 2014.

Are investors putting too much faith in central banks to rein in market tension? Market direction depends on Group of Seven monetary policy changing. To understand and appreciate the G-7 curve will yield greater long-term awards. All the forex market requires is for a central bank to tighten and there has been talk.

The Old Lady Grows Uneasy

The U.K. economy has been on a roll with strong growth numbers, more jobs, and a housing boom (potential bubble). It’s an economy envied by many other developed nations. The Bank of England (BoE) is widely expected to be the first of the major central bank to hike rates, even before the year is out (fixed-income dealers have a hike priced in for November). The market scours for clues for that possibility, and if and when confirmed, dealers will know what positions to protect or discard.

To the surprise of a few, today’s Monetary Policy Committee (MPC) minutes for last month’s BoE meeting were decisive. Members voted unanimously to leave the benchmark rate at a record low of +0.5% in July. The minutes made it clear that there is as yet no preferred timing for a first raise in the rate. As per usual, there were arguments for and against, but no sense of a partial consensus. Indeed, the minutes suggest that there are many areas of uncertainty, including the amount of spare capacity (a central bank catchphrase) in the economy given that unemployment rates are falling and real wages have yet to rise.

Once the 9-0 vote was confirmed, GBP was sold albeit not aggressively (£1.7040); however, the 21-DMA (£1.7106) should now weigh more heavily on the pound short term. GBP longs will now become more reliant on an unlikely EUR/USD rise for support. Intraday speculators have interest to sell EUR/GBP rallies above €0.8010-20 in the short term. The reality is that today’s MPC minutes should be viewed as a wash for the market with relatively little impact. Incoming data is more important, and it’s prudent to look to tomorrow’s U.K. retail sales and Friday’s gross domestic product numbers for directional GBP inspiration.

Stevens’s Jawboning to Continue?

The Antipodean currency pairs certainly have vocal central bank backing. If it’s not the Reserve Bank of Australia’s (RBA) Governor Glenn Stevens attempting to ‘jawbone’ the AUD down, then it’s Governor Graeme Wheeler at the Reserve Bank of New Zealand (RBNZ) highlighting how overvalued the Kiwi is in relative terms. Both central banks are supposedly on the cusp of actually doing something to their monetary policies. The NZD and AUD has been the recipients of much love from a ‘carry’ trade perspective for a long time and it’s no wonder that policymakers gripe about the high value of their own currencies from a competitive sense. In times of low volatility, investors have been happy to reach for yield, which both central banks amply supply.

There was a sliver of hope that the RBA could be in a position to possibly ease rates soon, however, overnight data should dispel any such ideas. Rising Aussie second-quarter price pressures should be capable of thwarting any RBA easing. Australia’s core consumer prices gained more than economists forecast last quarter, affirming policymakers’ decision to adopt a neutral interest-rate stance. The AUD/USD has rallied, breaching the psychological $0.94 level to trade $0.9445 as investors pare bets on a further cut to the record-low 2.5% cash rate.

Accelerating inflation poses a dilemma for the RBA — certainly makes jawboning the AUD lower non-effective and higher rates makes it more difficult to face a slowdown in growth, especially when mining investments wane, and the government is actually cutting spending.

Kiwi Bulls to Tread Softly

The RBNZ faces a difficult decision this evening at its monetary policy meet. This is the central bank that pioneered “forward guidance” and the markets have priced in an 85% chance that the governor will endorse a fourth straight -25bp hike to +3.50%. To do anything else the RBNZ will have “ambushed the market” and it will lose all credibility. It’s all about fine-tuning and keeping the correct balance when making any changes — the bank should be subtle to prevent hurting growth. Governor Wheeler needs to convince the markets that RBNZ policies are calibrated in sync with the domestic economy (a hit to sentiment from lower dairy prices, manufacturing job losses, etc.). Wheeler needs to plainly sign post the bank’s intent for the remainder of this year. The risk is that the RBNZ fails to signal a pause for the rest of 2014, but “stays fixated on balancing potential growth versus potential output.” The outcome will determine if the market gets a new high (NZD$0.8689). If the pause comes sooner and more extended, Kiwi bulls could be in trouble!

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Dean Popplewell

Dean Popplewell

Vice-President of Market Analysis at MarketPulse
Dean Popplewell has nearly two decades of experience trading currencies and fixed income instruments.
He has a deep understanding of market fundamentals and the impact of global events on capital markets.
He is respected among professional traders for his skilled analysis and career history as global head
of trading for firms such as Scotia Capital and BMO Nesbitt Burns. Since joining OANDA in 2006, Dean
has played an instrumental role in driving awareness of the forex market as an emerging asset class
for retail investors, as well as providing expert counsel to a number of internal teams on how to best
serve clients and industry stakeholders.
Dean Popplewell