Analysts’ Pick: NZD/USD looks tilted to the downside ahead of the RBNZ’s monetary policy decision tomorrow
- Economic data has fared better than the RBNZ’s forecasts, which may prompt a delay for additional monetary stimulus from the central bank.
- Underlying data still tilts the New Zealand economy towards the downside, especially with an expected spike in unemployment when the government’s Wage Subsidy Scheme ends on September 1st.
- Global economic headwinds will also weigh on tourism in New Zealand and other exports, which should fall into policymakers’ consideration and result in an increase to the LSAP programme ceiling or introduction of yield curve control tools at tomorrow’s meeting, if not at the September’s meeting.
The Reserve Bank of New Zealand (RBNZ) looks set to hold its official cash rate at 0.25% at its monetary policy decision tomorrow at 10am (GMT +8). But there may be room for the central bank to expand its asset purchases program to help accommodate an expected increase in bond issuances, even if not at tomorrow's meeting.
At its previous monetary policy meeting in May, the RBNZ expanded its Large Scale Asset Purchase (LSAP) programme limit from NZ$33 billion to NZ$60 billion, while keeping its official cash rate unchanged at 0.25%. In its statement, the RBNZ said that the reason for the expansion to the LSAP was to reduce the cost of borrowing quickly and sharply, in line with an aggressive monetary policy strategy to prevent a worse-than-expected outcome in the absence of such a strategy. Also, in the central bank's statement was a more dovish tone than before, highlighting the uncertainty in the current economic environment as well as its pledge to keep interest rates at current levels until early 2021 while opening the door to an additional expansion to the LSAP programme’s ceiling.
Despite the weak economic outlook from the RBNZ, the New Zealand economy has managed to remain resilient to the economic headwinds. Employment data in particular, shows that the New Zealand labour market remains stronger-than-expected. The RBNZ forecasted unemployment to reach 7.0% for the second quarter of the year, while employment to fall 4.5% QoQ and 3.6% YoY. Q2 figures released last week showed employment falling only 0.4% QoQ and growing 1.2% YoY. Unemployment rate was 4.0% for Q2 2020, beating both the RBNZ's baseline scenario and economists' forecasts.
The labour market has remained more resilient than the RBNZ expected amid the Covid-19 crisis
While headline labour market data looks strong, the figure masks what is likely to be a distortion by the government's Wage Subsidy Scheme. Underutilisation rate spiked in June to 12% YoY, with Stats NZ showing an increase in both underemployed workers (workers who would like to work more hours, worked less than a specific threshold of hours and were available to do so in the reference week) and available potential jobseekers (people who are not actively seeking a job but were available in the reference week and want a job). This signals that unemployment is likely to be greatly supported by the Wage Subsidy Scheme, which implicitly means that we will see a spike in unemployment when the programme comes to an end as well.
Underutilisation rate suggests that headline unemployment may be understated as the wage subsidies help keep jobs afloat
Inflation has also beaten expectations, likely supported by the recovery in commodity prices. Headline CPI declined 0.5% QoQ in Q2 2020, beating economists' expectations of -0.6% and the central bank's baseline forecast of -0.7%. This translated into an outperformance YoY as well (A: +1.5% YoY, E(economists): +1.3%, E(RBNZ): +1.3%). While inflation beat forecasts, weakness in the global economy and the New Zealand dollar’s 15.91% surge against the dollar since March 2020 suggests that inflation will likely remain low and possibly fall below the RBNZ’s target range of 1% to 3%. The same can be seen in GDP data for Q1 2020 as well, although Q2 data for GDP will be more of a concern for policymakers.
The New Zealand dollar is trading close to year-to-date levels after rising 15.90% since March’s lows, which will likely result in lower demand for its exports
While back dated economic data signals that the RBNZ may be too pessimistic in their baseline scenario (also their most optimistic scenario), the New Zealand economy will likely continue to face more headwinds moving into the rest of the year. Tourism (contributing to 20.4% of total exports, a 5.8% direct contribution and a 4% indirect contribution to New Zealand's total GDP for the year ended March 2019) in the country is expected to continue to remain at low levels as the pandemic impacts international air travel. While domestic and restricted international travel may help alleviate some of the downward pressure off the industry, demand is still likely to remain at low levels as uncertainty remains a key decision on consumer decisions on spending as well as travel decisions. The country's largest trade partners' (Australia, US, China) also face economic uncertainty and will likely have an impact on New Zealand exports, further cementing impending headwinds for the country.
The above suggests that while economic figures have generally been better than what the central bank expects, the risks are still skewed towards the downside. As a result, we think policymakers will keep monetary policy unchanged with a possibly more optimistic outlook to the economy, while reinforcing strongly its dovish tone on future monetary policy to curb gains in real interest rates. The RBNZ is likely to also strongly consider expanding its LSAP programme, with a possible hint at other tools such as a yield curve control tool to keep rates low to better support fiscal spending at either tomorrow’s meeting or if not, at the next. The New Zealand dollar may have room to weaken as a result, possibly towards 0.6584's level in the short-term at the decision tomorrow. The dollars' upward momentum may also be able to put more downward pressure on the currency pair, although we do not think that the recent reversal in the dollar's decline is sustainable in the short-to-medium-term.
The Kiwi looks to be in a downtrend as the dollar starts to recover from an extended decline. Dipping past the 50-day moving average suggests that a normalisation is occurring, possible back closer towards the 200-day moving average. With a possible downtrend catalyst from the RBNZ’s decision, the Kiwi looks likely to retest the 0.6584 support level and possibly break it and trend closer towards 0.6550’s level. The short-term downward momentum in the dollar may also help with this (as evident from a potential bearish signal from MACD), although the decline in the dollar looks likely to only be a correction at this juncture instead of a full-on downward trend (NZD/USD is still trading well above the 78.6% Fibonacci retracement level). As a result, the outlook for the Kiwi looks likely to be tilted to the upside against the dollar, although we do not expect the Kiwi to strongly outperform other major currencies as the global economic slowdown is likely to continue to impact the New Zealand economy.
Support: 0.6584 / 0.6550 / 0.6519
Resistance: 0.6623 / 0.6670 / 0.6708
NZD/USD Chart (H4)