Tuesday, May 12, 2020

Does the current situation warrant the RBNZ slashing interest rates past zero?

  • Dollar
  • NZD
  • Reserve Bank of New Zealand


Analysts’ Pick: Does the current situation warrant the RBNZ slashing interest rates past zero?

  • RBNZ will probably not venture in to negative rate territory today, but there may be an expansion to its quantitative easing program
  • With additional fiscal stimulus from the government, the RBNZ will probably increase its overall limit for asset purchases to accommodate a surge in issuance of government debt
  • NZD/USD may fall on Wednesday as a result, and may be further dampened as Fed Chair Powell is unlikely to encourage the possibility of negative rates in the US

The Reserve Bank of New Zealand (RBNZ) looks likely to keep rates unchanged but the focus will be on a potential expansion of its quantitative easing program during this week’s monetary policy decision instead. The central bank announced its Large Scale Asset Purchases Programme (LSAP) during its meeting on March 11th, in which it will buy up to NZ$30bn worth of New Zealand Government bonds and NZ$3bn worth of Local Government Funding Agency (LGFA) debt in the secondary market over a 12 month period. At the original stated pace of NZ$750mn per week, the asset purchase program would have lasted a total of 44 weeks. But the bank has made a total of NZ$9.42bn worth of purchases as of the week ending May 8th since the start of its quantitative easing program, which sets it at an approximate average pace of NZ$1.18mn per week. This would mean that the asset purchase program would hit its limit in 20 weeks, assuming the central bank continues at the current pace of purchases.

The RBNZ has used up almost a third of its total allocated budget for asset purchases, which suggests that the central bank may reach its target in 20 weeks


With the expansion of fiscal stimulus measures to help New Zealanders amid the Covid-19 pandemic in mid-April, the central bank will likely boost its quantitative program to help accommodate the changes that will likely result in more bond issuances from the New Zealand government.

Negative interest rates should be uncalled for during this meeting, and the financial market has mostly already priced this in with overnight index swaps tracking the central bank's decision implying a 12% probability for a rate cut. We do agree, since more recent economic data suggests little need for additional monetary stimulus in the form of an outright interest rate cut. ANZ's business confidence for May showed improvements over April while a sharp surge in New Zealand exports to China at the end of April and beginning of May will likely also deter the central bank from immediately cutting interest rates at Wednesday's decision. The surge in exports should help to offset the decline in exports to the rest of the world amid the lockdown as well as to its tourism industry. Furthermore, it is likely that the extent of the lockdown has mostly peaked in the month of April, and more cities and countries should start to incrementally ease Covid-19 restrictions over the next few weeks or months which should help exports to recover slightly.

Overnight Index Swaps imply that traders are not expecting an interest rate cut tomorrow


Exports from China surged towards the end of April as the China’s workers start to return to work after the Covid-19 lockdown


Since Australia and China are two of New Zealand's largest trading partners, the New Zealand economy should benefit from both these countries reopening their respective economies ahead of the rest of the world. But this also implies that there is a potential risk of a second wave of the virus, which we are starting to see. With a high rate of infection, the likelihood for new clusters of the Covid-19 virus will not remain low for long as countries start to reopen their economies. But risks of another full shutdown should be relatively low, since governments should have increased their rate of testing and improved contact tracing methods. In addition, there should be some upside for commodity-related currencies in the short-term as the current global supply chain disruption should mean there will be a temporary surge in demand for commodities to meet the short-term demand.

Hence, we expect the RBNZ to expand its asset purchases, while keeping rates unchanged. Forward guidance should be relatively positive as compared to previous meetings, but Governor Adrian Orr will likely still signal the central bank's commitment to support the economy as well as liquidity in the debt market. This should push the New Zealand dollar down in the hours following the announcement. The kiwi may also face pressure from a stronger dollar on Wednesday, as Fed Chair Jerome Powell is set to speak on current economic issues. We expect Powell to echo other Fed officials' thoughts on negative interest rates by downplaying the benefits of having it in the US amid the Covid-19 pandemic, which could boost the dollar as speculation move shifts slightly away from the possibility of negative interest rates. NZD/USD may as a result fall and break 0.6057’s level on Wednesday, although it may see a rebound later in the week back towards 0.6103’s level.

Fed Fund Futures suggest that markets are expecting the Fed to cut rates below zero


Technical Analysis:         


The New Zealand dollar has been volatile in the past 8 weeks, thanks to the Covid-19 pandemic. Wednesday’s monetary policy may spur another selloff and bring the kiwi back to zero on Stochastics’ RSI, which suggests some upside potential for the currency pair. Bears and bulls are likely tying to take control of the currency pair with a strong support near the 61.8% Fibonacci retracement level. Wednesday’s RBNZ monetary policy decision may help the bears if the central bank decides to expand its asset purchase program or suggest a possible rate cut in to negative interest rates at its next meeting. But there should be more room for upside in the short-to-medium-term, as risks start to ease and as the dollar may show some weakness as a result. This could potentially help bulls push the currency back towards 0.6103’s level as a result.

Support: 0.6057 / 0.6037 / 0.6004

Resistance: 0.6103 / 0.6120 / 0.6145

NZD/USD Chart (H4)