Talking Points:
- NZD/USD may be in bear flag in downtrend from July 2014.
- EUR/NZD base solidifying, but needs N$1.6575.
The biggest central bank event on the calendar this week is the Reserve Bank of New Zealand rate decision, and it looks like it could spur a big move in the New Zealand Dollar - no matter what the central bank does. Ahead of the meeting, Credit Suisse Overnight Index Swaps are pricing in a 61% chance of a 25-bps rate cut, while 3-month New Zealand government bills are implying only a 46% chance of a rate cut.
These estimations tell us that the market is engaged in a tug-of-war: about half the market sees a cut while the other half sees inaction. Collectively, there is a large contingent of traders on the wrong side of the RBNZ decision, even before it occurs, which means there will likely be a large move on the decision, one way or the other: about half the market engaged in New Zealand rates instruments and the New Zealand Dollar will have to readjust.
Chart 1: NZD/USD Spot versus 3-mo Implied Bank Rate for 12/17/15
To illustrate this point, the above chart shows the relationship between the 3-month bill implied bank rate for December 17, 2015 since June 9, 2015 versus the NZD/USD spot price over the same time frame. This relationship is statistically significant with a six month correlation of +0.81.
Given the estimation that the RBNZ's main bank rate will be at 2.79% on December 17, a 25-bps rate cut tomorrow - from 2.75% to 2.50% - could dislodge the 3-month bill implied bank rate, and thus, the NZD/USD sharply lower. (This bodes well for our other preferred NZD-centric setup, EUR/NZD as first described yesterday.) Accordingly, should the RBNZ not cut rates, a short-term short covering rally seems likely; the NZD/USD downtrend from July 2014 would still be valid so long as price holds below $0.6900.
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