Article / 16 December 2015 at 0:56 GMT

NZDUSD primed for action ahead of Fed meeting

Managing Director / Technical Research Limited
New Zealand
  • Prices come in under expectations at latest dairy trade auction
  • Markets pricing in only one-in-three chance on another RBNZ rate cut
  • No leaks to the contrary suggests that the FOMC is ready to raise rates

By Max McKegg

NZDUSD
has had its wings clipped over the last 12 hours but still looks firm heading into the Federal Open Market Committee  meeting. A weaker than expected dairy trade auction and a solid US inflation report that boosted the USD, saw the Kiwi coming off a one month high of 0.6825 to settle around 0.6760.

Outperformance against the AUD continues. In the fortnightly dairy trade auction, whole milk power prices rose 2%. Futures markets had suggested a 9% increase. New Zealand is the world’s largest exporter of dairy products and has been reducing the amount on offer for some time. Expectations are that the El Nino weather pattern will further reduce production over the summer months. However this is being counteracted by excess supply in the European Union.

In its Monetary Policy Statement last week, the Reserve Bank of New Zealand listed export prices as the main downside risk to its economic forecasts. As dairy products comprise about a third of the country’s good exports, activity in that area is a key indicator.

xxx
 Expectations are that the El Nino weather pattern will reduce NZ milk production. Photo: iStock

The RBNZ’s baseline case (“Central Projection”) is that export prices will increase gradually over the next three years. But the margin for error is slim. The bank says that in a scenario where instead of a gradual rise export prices decline 6% or more over that period “the consequent fall in national incomes would be significant and protracted”, acting as a further drag on already below-target inflation and therefore warrant more monetary policy stimulus.

They calculate that “interest rates would need to be about 50 basis points lower” for inflation to remain on track to the 2% target.
 
As the chart below shows, the RBNZ’s central projection has the key 90-day interest rate holding steady over the next couple of years at 2.6%. But a relatively moderate 6% fall in export prices would see them lowering it to 2.1%. Given the downward pressure on global commodity prices, this scenario is well within the realms of possibility.

Scenario for 90-day interest rates


90 day interest rates













 Source: Reserve Bank of New Zealand
 
But at the moment money market and FX traders prefer to look on the bright side. Hence the resilience of NZDUSD over recent weeks. Bank governor Graeme Wheeler lowered the Official Cash Rate last week to 2.5% and Overnight Index Swap pricing suggests there is only a moderate expectation he will ease again next year.

We’ll see about that. It seems to me the markets are underplaying the chance of further falls in dairy prices and hence the interest rate cuts the RBNZ says would follow. But that will be next year’s story.


OIS
 














Source: Westpac
 
Clearly the biggest influence on NZDUSD over the next 24 hours will be the US rate decision, but a couple of hours later we will get an update on New Zealand’s economic growth. A 0.80% increase in third quarter GDP is expected, suggesting the economy is humming along at a satisfactory level. A miss of 0.2% or more would be required to impact the currency.


NZ GDP growth
 




















Source: ASB Bank
 
And so to today’s big event. As they headed into the two-day meeting yesterday, the bulls on the FOMC will have been encouraged by the latest update on inflation via the Consumer Price Index.

As the chart below shows, the headline rate rose 0.50% year on year, slightly ahead of expectations, while the core rate has hit the magical 2% level. However, the Federal Reserve’s benchmark inflation measure, the price index of Personal Consumption Expenditures (PCE) remains somewhat below that number, something chair Janet Yellen is sure to comment on in her press conference.

US CPI
Source: Advisorperspectives.com
 
The stage is set for the final big economic event of the year. Market pricing suggests an 80% chance the FOMC will take the first step on a long, slow path to interest rate normalisation, and as there have been no leaks to the contrary directed at the usual media insiders, we can assume Janet Yellen has the numbers.

The reaction in the FX markets is hard to predict, but price action in NZDUSD seems to suggest it will be the old story of buy-the-rumour-sell-the-event for the USD.

My technical analysis of NZDUSD (which I base all my own trading decisions upon) appears below : 

NZDUSD daily chart (click to expand)
NZDUSD daily chart
Source: ThomsonReuters

-- Edited by Adam Courtenay

Max McKegg is managing director of Technical Research Limited. If you would like an email notice each time Max posts a trade, then click here to follow him.

3y
Treve Treve
well written and informative!
3y
tradingwithapro tradingwithapro
This comment has been redacted
3y
Patto Patto
I agree Max. Just as the Kiwi rallied when the RBNZ cut rates last week, the USD will sell off after the fed hikes. Strange but true..............

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