The lack of U.S. economic data this morning has once again led to relatively quiet trading in the foreign exchange market. Oil prices moved slightly higher but not by enough to make new headlines. Continued tensions in Libya has kept oil prices firmly above $100 a barrel, leaving high commodity prices as the greatest near term risk for the global recovery. Better than expected economic data from Europe helped to lift the euro, British pound and Swiss Franc while the Australian dollar benefited from RBA's upbeat comments. While many investors will continue to keep their focus on oil, the more interesting event risk over the next few hours will be the Reserve Bank of New Zealand's monetary policy decision.
For the first time since 2009, the RBNZ is expected to lower interest rates from its current level of 3.00 percent but the decision will not be an easy one and there's a relatively decent possibility that the RBNZ could hold rates steady. Most of the arguments in favor of a rate cut center around the Feb 22 earthquake that shut down New Zealand's second largest city. Not only is Christchurch responsible for 11 percent of the national GDP, but the cost of the quake is expected to reach $11 billion. For a country with a GDP of approximately $127B, $11B is a huge expense. However even before the quake, the New Zealand economy was suffering. In the third quarter, growth contracted by 0.4 percent. Since then we have seen both retail sales and employment levels decline, leading to a warning by the Finance Minister that growth could have fallen in the fourth quarter as well, putting the country back into a technical recession. Yet, with inflation rising and growth expected to accelerate due to rebuilding efforts, a rate cut may not be needed. In fact, Finance Minister English said last night that growth could be in excess of 4 percent next year and lowering interest rates now could risk stronger inflationary pressures in the future. The RBNZ's mandate is to maintain an inflation rate between 1 and 3 percent. The latest CPI report showed consumer prices growing by an annualized pace of 4.0 percent. As indicated by the list below, the RBNZ has good reasons to both lower and hold rates steady.
Why the RBNZ Should Cut Rates
1. Negative impact of earthquake on New Zealand economy
2. Very good chance NZ experienced negative growth in Q4, putting the country back into a technical recession
3. Latest retail sales report showed consumer spending falling 1.1 percent in Dec
4. Unemployment rate rose from 6.4 to 6.8 percent in Q4
Why the RBNZ Should Leave Rates Unchanged
1. CPI rose 2.3 percent in Q4, up 4.0 percent yoy
2. Higher oil prices should have driven inflation expectations higher
3. NZ government sees the quake as having a short term negative impact on the economy
4. Prior to the quake, RBNZ Governor Bollard has been leaning towards tighter monetary policy
Of the 15 economists surveyed by Bloomberg:
How the New Zealand Dollar Could React to the RBNZ Rate Decision
Although the consensus forecast favors a quarter point rate cut, individual forecasts show a far greater divergence in views. Since someone is bound to be surprised, we can expect a great deal of volatility in the New Zealand dollar. Interest rate decisions are notoriously big market movers for a currency but in the case of the New Zealand dollar this month, the volatility could be unusually large so traders should adjust their risk accordingly. Aside from the actual change in interest rates, the tone of the RBNZ statement will also be important. Based upon what the RBNZ says and does, here is how we believe the New Zealand dollar will respond:
New Zealand Dollar: Levels to Watch
Following the interest rate decision, here are the levels to watch in the NZD/USD. Since the end of May, the currency pair rallied over 1400 pips or 22 percent and has declined more than 500 pips since its peak. The nearest level of support is near the six month low of 0.7340, which provided strong support over the past six months and which corresponds to the lower-two standard deviation Bollinger Band. If this level is broken, the pair could find further support at the 50% Fibonacci Retracement of 0.7267, drawn from the May low of 0.6560 to the November high of 0.7974. If a bear rally ensues, the 61.8% Fibonacci Retracement of 0.7100 should provide major support. The nearest level of resistance would be the 38.2% Fibonacci Retracement of 0.7434, which coincides with the 10-day simple moving average. If this level is crossed, the 20-day simple moving average of 0.7515 should serve as further resistance.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.