NZD/USD drops back towards 0.7150 amid pre-FOMC technical selling pressure

• NZD/USD has been heading lower for most of Wednesday’s session after breaking to the downside of a pennant structure.
• The move has also been exacerbated by a pre-FOMC rise in US government bond yields.
• The FOMC event and then New Zealand Q4 2020 GDP data will be the key events in the coming hours.

NZD/USD has been heading lower for most of Wednesday’s session ahead of the release of the latest FOMC rate decision, updated dot-plot and economic forecasts at 18:00GMT; the pair has dropped from its Asia Pacific session levels in the 0.7180s to current levels just last Friday’s low in the 0.7150s. At present, the pair trades lower by about 0.4% or 30 pips on the session, with the kiwi currently sitting close to the bottom of the daily G10 FX performance table, though not faring as badly as AUD, which is over 0.5% lower on the day versus the US dollar.

Driving the day

Kiwi traders largely shrugged off as expected Q4 2020 Current Account data released during Wednesday’s Asia Pacific session; in terms of the domestic New Zealand economic data calendar, the main focus of the week is the release of official New Zealand Q4 2020 GDP data at the start of Thursday’s Asia Pacific session (at 21:45GMT on Wednesday).

As to why NZD/USD has been on the back foot for most of the session, there are two explanations; 1) technical selling – since the start of last week, NZD/USD had been consolidating within a pennant structure, but seemed to break to the downside of this during Wednesday’s early European session and 2) US government bond yields have been moving higher in anticipation of the FOMC event, putting upwards pressure on US/New Zealand rate differentials, which is bearish for NZD/USD.

Other than that, there has not really been any other important fundamental developments so far on the session.

Fed Preview

The FOMC is expected to hold interest rates at their zero-lower band (0.0-0.25%) and the rate of asset purchases steady at $120B per month (of which $80B are US government bonds).

The Fed statement and Fed Chair Jerome Powell’s remarks in the press conference are likely to stick to the usual dovish tone; i.e. no rate hikes until the bank has met its updated dual mandate (i.e. full employment and inflation that is moderately and sustainably above 2.0%), something which the Fed is likely to reiterate is still a long way off, and no tapering of asset purchases until substantial further progress has been made towards its dual mandate (something which Powell is also likely to say is a long way off).

The Fed will be releasing new economic projections which will be more closely scrutinised than usual; officials have been talking about how they expect inflation to pick up in the short-run and the updated inflation forecasts will formalise such expectations. The updated dot-plot is also of note; markets have brought forward their expectations of the first Fed hike as soon as late-2022/early-2023, despite the Fed’s old dot plot not forecasting any hikes through to 2024. Maybe the new dot plot might foresee a hike in 2023 (if not, that would be dovish).

Meanwhile, traders will also be on the lookout for any more information of if, when, and how the Fed might respond to further increases in US government bond yields, as well as any hints as to the conditions the Fed might want to see before tapering asset purchases – more information on the former is more likely than on the latter, as the Fed will likely want to avoid causing yields to move higher.

A few technical factors are also worth considering; bank SLF relief (which means they do not have to hold capital reserves for their treasury holdings) is set to expire this month and the Fed needs to decide whether to extend this. If not, this could cause some market problems as banks rush to meet their new, higher capital requirements. Some desks also think the bank might tweak the Interest of Excess Reserves Rate (IOER), which is a tool the bank uses to keep the Federal Funds rate within its target band – if they do, they will insist that this does not constitute a tweak to monetary policy, rather just a technical adjustment to maintain policy.