US Dollar Rebound Spells Further Downside for the Kiwi Dollar

By: AnyOption

With rhetoric for US rates hikes ramping higher while other advanced economies across the globe consider the merits of additional accommodation, the US dollar has found itself on the mend after several weeks of softness.  Even though US macroeconomic data has been mixed and at times disappointing, first quarter growth is projected to be strong, paving the way for additional tightening while countries such as New Zealand contemplate lowering benchmark rates even further. 

After the surprise rate cut earlier in the month, the Reserve Bank of New Zealand looks poised to accommodate policy further in an effort to insulate the economy from external developments, sending the local currency lower.  With trade faltering and increased risks of sliding into deflationary territory, NZDUSD might be poised to reverse sharply lower following the post-January bounce.

Who Let the Hawks Out

Hawkish commentary from prominent Federal Reserve members over the last week including St. Louis Fed President James Bullard and Chicago Fed President Charlie Evans have sent the US dollar bounding higher following several weeks of dismal results. With both policymakers elaborating on the potential for a 25 basis point rate hike as soon as April if economic conditions continue to improve, the probability of a rate hike in the first half of 2016 is rising demonstrably as evidenced by Fed Funds Futures.  At present, the probability of an April hike to 0.75% according to the CME Group FedWatch tool based on the 30-day Fed Funds futures prices is 13.90% whereas June sees that probability rise to 41.00%. 

As time passes, speculation of additional rate hikes also grows markedly, providing further evidence of the shifting market sentiment towards the Federal Reserve’s ongoing tightening measures.  While probabilities of additional action are rising, fueling gains in the dollar, there are several concerns that could derail progress on normalizing monetary policy.  In particular, inflation and no clear end to the troubles facing both advanced and emerging economies globally might be the sole points of contention amongst FOMC voting members during the April meeting.  The consumer price index while subdued at a 1.00% annualized pace, is still head and shoulders above most other advanced economies.  However, the preferred Fed gauge of inflation from personal consumption expenditures (PCE) was last reported at 1.25% on an annualized basis back in February, still below the Central Bank’s term target of 2.00%.

Resolution to slumping trade and weak expansion across Asia is a lingering concern as evidenced by the most recent decision and when combined with commodity deflation, the outlook remains murky.  Nevertheless, improving employment and GDP growth may continue to boost the dollar, especially with the Atlanta Federal Reserve GDPNow model projecting 1.90% expansion in the first quarter.  Although labor force participation remains a sticky component of employment, further gains in job creation are anticipated in the coming months.  While not all economic data agrees with the tightening policies of the Central Bank, certain policymakers are emphasizing the imperative of raising rates if inflation overshoots despite forward looking projections tumbling.  Taken in concert, these factors will undoubtedly contribute to sustained upward momentum in the US dollar over the near-term.

Creeping Towards Deflation

While US bankers are worried about inflation potentially overheating past target, policymakers in New Zealand are tangling with the opposite problem, and growing ever more wary of the encircling deflationary forces facing the nation.  With headline consumer inflation printing at 0.10% on an annualized basis according to data released for the fourth quarter, additional accommodation might be warranted to restore consumer price growth.  This level marks the lowest inflation the region has faced since 1999 on the heels of the Asian financial crisis that transpired in 1997 and swept across Southeast Asia.  The response was a surprise slashing of the key rate by 25 basis points during the March meeting, with warnings that more action may be forthcoming should forward-looking inflation expectations become less firmly anchored. 

At present, markets are predicting another rate cut in the second half of the year, putting the RBNZ benchmark at 2.00% as soon as the third quarter should problematic conditions in Asia, slowing growth in Europe, and troublesome developments in the dairy sector disrupt progress towards meeting the inflation goal.   Growth has remained fairly insulated, but policymakers may be grappling with keeping competitive, hence the value of an additional rate cut in the coming quarters.  Even though the New Zealand dollar has recovered substantially from multi-year lows reached back in August, there is a strong possibility that supplementary accommodative measures could send the currency tumbling once more.  From a policymakers perspective, this is the easiest manner to accomplish all goals including raising inflation, improving exports, and adding to GDP growth. 

The Play

The US dollar has made great strides in the past few sessions on renewed hawkishness on the part of Fed policymakers.  With peers at the RBNZ singing a different tune, the stage is set for another round of weakness in the NZDUSD pair.  Although chasing after the momentum of the last few sessions is not wise considering the US dollar’s quick ascension, a pullback might be a wise time to consider more medium-term Put positions targeting January lows of 0.6348 before retesting 0.6197 on a longer-term basis.  Considering the diametrically opposed policies of the two Central Banks, another round of tightening and loosening for the Fed and RBNZ respectively would be enough to cut short the multi-month bounce in the NZDUSD pair, creating a tremendous opportunity for investors to establish Put positions.

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