RBNZ Preview: Coronavirus should limit upside potential for NZD/USD

• RBNZ could lower OCR forecasts due to coronavirus threat.
• The economic backdrop is on a firmer footing. 
• The technical landscape for NZD/USD is mixed between 78.6% Fib target and 0.6580s, (50% upside retracement). 

The Reserve Bank of New Zealand is a highlight for this week. The Monetary Policy Committee will begin meeting next week for the first time since November. Market pricing for RBNZ implies a near-zero chance of easing on 12 February, with a terminal rate of 0.85% (RBNZ OCR currently at 1.0%).

Understanding the impact of the global economy and its effects on New Zealand are critical to the Reserve Bank when it considers Monetary Policy. The Reserve Bank lowered the Official Cash Rate by 75 basis points in 2019, due in part to the slowdown experienced by the country’s trading partners. It will, therefore, be interesting to see how the central bank will balance their rhetoric when taking into consideration the risks associated with the coronavirus, despite a wholly improved domestic economic backdrop until this point. 

Indeed, the Bank is likely to acknowledge better than expected outcomes for Gross Domestic Product, Consumer Price Index, wages and fiscal stimulus as positives but shy away from any overly ambitious outlooks when they have a very sick Chinese economy and a highly contagious virus on their doorstep. 

"Ordinarily, we would see the Bank upgrade its forecasts on the back of these outcomes, but we think the Bank is likely to keep its forecasts unchanged, sounding out a cautious note given the risks the coronavirus poses to the economy,"

analysts at TD Securities pointed out. 

RBNZ to take its cues from RBA's Lowe on coronavirus

This is a fast-moving situation and one might expect the RBNZ to rehash much of what Reserve Bank of Australia, Phillip Lowe, had to say on the matter when speaking last week when he downplayed how much monetary stimulus might be able to help Australia.

Troublingly, Lowe pointed out, however, that the coronavirus outbreak could do more damage to the Australian economy than 2003’s Sars outbreak, noting that China’s economy is now bigger and more integrated into the world economy so the impact is likely to be greater. “The potential risk to the Australian economy I think is bigger than Sars and the truth is really none of us know how this is going to play out,” Lowe said appearing before the House of Representatives economics committee in Canberra on Friday.

On Monday, the Shadow Board members deemed it prudent for the Reserve Bank to wait and see how the effects play out,” said Christina Leung, Principal Economist at NZIER – more here: Shadow Board recommends no RBNZ rate change this week. Indeed, there remains a wide range of views amongst the NZIER Policy Shadow Board on the appropriate level of the OCR due to the added uncertainty over how long the coronavirus will persist.

Meanwhile, in a speech to the Goldman Sachs Annual Global Macro Conference in Sydney, Reserve Bank Assistant Governor, Christian Hawkesby, set out the framework the Bank used to analyse the global economy and its influence on New Zealand. He said that the RBNZ was monitoring the impact of the coronavirus through all three channels. “The SARS virus in the 2000s provides some potential parallels, particularly through the effects on travel and confidence,” Mr Hawkesby said.

He also stated that prolonged uncertainty, particularly around Brexit and US-China trade tensions, was likely to have affected business confidence and investment. “While New Zealand businesses cited a number of domestic factors, uncertainty about the global environment is likely to have also played a part,” Mr Hawkesby said.

RBNZ OCR forecast to be anchored by the coronavirus

Looking to the economy, analysts at Westpac use their Ready Reckoner which quantifies the impact that recent data will have on the RBNZ's Official Cash Rate forecasts. (The Ready Reckoner is meant to be a pure read on how the balance of recent data will affect the RBNZ's models, not a prediction of the RBNZ’s actions).

On an "ex coronavirus" basis, "the result is very positive," the analysts said, "This tells us that if it weren't for coronavirus, the RBNZ would have lifted its OCR forecast and abandoned its easing bias."

"However, coronavirus adds a significant extra layer of uncertainty - we do not know how much allowance the RBNZ will make for the coronavirus, but we know it will be negative. The RBNZ's actual OCR forecast will, therefore, be lower than the Ready Reckoner calculations presented."

Key notes of the Ready Reckoner:

• GDP: +15bp: This is mainly due to the large upward revision to 2018 GDP growth. September 2019 GDP growth was 0.7%, compared to the RBNZ's forecast of 0.3%. However, June quarter growth was revised down from 0.5% to 0.1%. 
• Inflation: 0bp: Although December quarter inflation was higher than the RBNZ's forecast, this was almost entirely due to transitory factors that will unwind.
• Exchange rate: -10bp: Before coronavirus starting affecting markets, the TWI was around 2% higher than the RBNZ's previous forecast. 
• Unemployment: +5bp: December quarter unemployment was 4.0%, compared to the RBNZ's forecast of 4.2%. Employment growth was actually lower than the RBNZ's forecast. Nevertheless, the labour market is clearly tighter than the RBNZ expected. The underemployment rate fell to a new post-GFC low, and wage growth was stronger than the RBNZ anticipated.

Meanwhile, analysts at ANZ Bank lowered projections for NZ GDP to 0.8% for the first half of 2020 from 1.3%.

Key notes:

• The worrying novel coronavirus has led us to downgrade our first-half growth outlook. 
• Uncertainty is extreme. 
• We hope the virus is contained soon and the impact temporary.

How will the RBNZ affect NZD/USD? 

NZD/USD has been under pressure since topping out on the last trading day of 2019 up at 0.6755 in what appears to be a recovery and bottom of the 2018 downtrend. The price has completed a 61.8% retracement of the October 1st uptrend and meets the Sep-Dec resistance structure (Oct 2018 weekly support as well) which could well act as a major support structure.

• Bullish scenario: Price moves back to the 4th Feb lows and highs of 0.6449/00 which should hold an initial test. Should 0.6450 then act as a support and price bases there, the upside bias and a subsequent break of the 27th Jan lows 0.6540s and then the 0.6580s support structure (50% mean reversion confluence), then this could also start to validate the consensus for the cup and handle bottoming pattern on the daily chart of the 2018 downtrend. 
• Bearish scenario: However, given the near term risks, it is an unfavourable environment for the commodity complex for which the kiwi trades as a proxy. Should the RBNZ highlight the concerns for the coronavirus, and subsequently downgrade their OCR outlook, the 0.6320s will be in the picture, especially should the market continue buying the US dollar.