NZD/USD slumps on dovish RBNZ, US inflation report may revive hard landing risks

• RBNZ cuts cash rate by 25bps to 5.25%
• Updated forecasts imply another 100 basis points of cuts by mid-2025
• Markets favour three more rate 25bps cuts in 2024
• NZD/USD hammered towards .6000, US inflation report may revive recession fears

RBNZ delivers first rate cut since pandemic

The Reserve Bank of New Zealand (RBNZ) surprised economists but not traders in August, cutting its overnight cash rate by 25 basis points to 5.25%, the first reduction seen since the early stages of the pandemic. The decision was not a surprise to this scribe who expected the RBNZ to begin easing policy at today’s meeting.  

With a lot more to come this cycle

With swaps markets implying a two-in-three probability of a rate cut, the New Zealand dollar tumbled on the decision, undermined not only by the reduction but also the RBNZ's updated overnight cash rate (OCR) track that implied another 100 basis points of cuts by the middle of next year.

By December, the RBNZ sees the cash rate at 4.92% before falling to 3.85% by end-2025. Three months ago, it forecast 5.65% and 5.14% respectively. That’s a big dovish downshift.

Source: RBNZ

Markets are pricing in around 67 basis points of cuts by the end of the year, an outcome that would still leave the cash rate above the 3.9% neutral level estimated by RBNZ researchers earlier this this year. If we see a hard landing for the global economy, rate cut bets are likely to swell considerably.

Neutral rates are the level in which unemployment and inflation remain stable. It is a dynamic rate meaning it is constantly changing, creating the risk of policy under and overshoots.

Source: Refinitiv 

Beyond expectations for overnight rates, New Zealand two-year interest rate swaps have taken out the lows set last week when panic was gripping Asian markets, falling to levels not seen in two years. That’s how dovish the RBNZ’s shift has been interpreted.

Most New Zealand mortgages are priced off this rate, making it important in term of monetary policy transmission. It’s now down nearly 200 basis points from the high set last year and 120 basis points over the past three months alone.

Higher unemployment, return to recession forecast

Explaining the RBNZ’s dovish tilt, it forecast higher unemployment than three months earlier and a return to recession in the middle of this year, creating downside risks for inflation. That’s important as price stability is the RBNZ’s sole policy mandate, rather than low and stable inflation and full employment as like other nations such as Australia and United States.

Source: RBNZ

“New Zealand’s annual consumer price inflation is returning to within the Monetary Policy Committee’s 1-3% target band,” the RBNZ said at the top of its statement. “Surveyed inflation expectations, firms’ pricing behaviour, headline inflation, and a variety of core inflation measures are moving consistent with low and stable inflation.”

The big decrease in two-year inflation expectations in its own survey last week clearly played a part in the decision, along with estimates of greater excessive capacity in the New Zealand economy than previously forecast as shown by the large increase in labour market underutilisation and youth unemployment in the June quarter.

NZD/USD staring at bearish key reversal

NZD/USD fell sharply on the dovish surprise, reversing significant gains of a day earlier as a weak US PPI report for July led to an explosion in risk appetite. As things stand, we’re looking at a key outside day for the Kiwi on the daily timeframe. However, with expectations for a soft US CPI print permeating across markets, it would not surprise to see NZD/USD push back through the downtrend it smashed through successfully on Tuesday ahead of the report.

Support is located at .5985 and .5860 with resistance at the 200-day moving average, .6150 and .6218.

But this is the entre to the main event today

While I understand the market reaction, the truth is the RBNZ decision will be largely forgotten over the next few hours as traders turn their attention to the upcoming US CPI report, an event that carries the power to supercharge expectations for the Fed to deliver a 50 basis point rate cut or a smaller 25 basis point move in September.

Traders should look at the Kiwi as a play on the global economic outlook. So, if the risk of a hard landing is ebbing, it should help NZD/USD upside, and vice versus.

While a 50 basis point cut from the Fed sounds great in concept for riskier asset classes, if it’s done because activity is rolling over quickly, that’s not positive for risk; far from it. An ice cold US inflation report could do just that, amplifying recession concerns by implying a further weakening in demand. A 0.2% core reading should be an optimal outcome for risk assets, allowing the Fed to cut rates gradually without generating fresh economic fears. 

-- Written by David Scutt

Follow David on Twitter @scutty