How to trade a central bank divergence: RBNZ and RBA case study
|Central bank divergence
One of the first principles to teach aspiring FX traders is trading a strong currency against a weak currency. In this way, it is easier to determine direction. A great example of this is now occurring in the AUDNZD pair. We have reasons for continued NZD weakness against the AUD. This is due to a divergence in policy between the RBA and the RBNZ.
A dovish RBNZ
The RBNZ yesterday confirmed that it is prepared to use negative interest rates to boost the economy. This is a confirmation of the latest policy decisions from the RBNZ. In that decision, the RBNZ launched a set of bearish monetary policies. Firstly, the RBNZ increased their quantitative easing (LSAP) programme to $100bn. Secondly, they extended the length of the programme from 12 to over 20+ months. Thirdly, the RBNZ expressed their general reference for a lower /negative OCR and a ‘Funding for Lending Programme'. This is Bearish stuff. The impact in the NZD 10Y bond market was telling. A falling bond yield is indicative of lower interest rates.
A less bearish RBA
The RBA, on the other hand, is not actively pursuing negative interest rates. At present that would be an unlikely course of action. Yes, the Reserve Bank of Australia knows that negative interest rates would be a stimulatory benefit by putting downward pressure on the Australian dollar. However, they are probably wary that negative interest rates can cause unwanted stresses in the financial system.
AUDNZD upside
So, as a result, the AUD should remain stronger against the NZD. Therefore, buying on dips makes sense for the AUDNZD pair as long as this central bank divergence remains the same.
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