Central Bank Divergence

A central bank divergence can be a great way to pair up a weak currency against a stringer one. One of the tricky areas in trading FX recently has been that central banks have been cutting rates in a coordinated way. There has been a race to cut interest rates across all the banks. So, with all the central banks following the same path this has made a central bank divergence trade quite rare lately. However, the latest moves by the RBNZ has changed that. This is due to the RBNZ’s willingness to embrace native interest rates.

On Wednesday the RBNZ Monetary Policy Committee agreed to significantly expand the Large Scale Asset Purchase (LSAP) programme potential to $60 billion. However, this was pretty much expected. It was the potential for negative interest rates which caused the kiwi to sell off. RBNZ’s deputy Governor Geoff Bascand confirmed that the RBNZ would like to be ready for negative rates by the end of the year. When a central bank reduces interest rates this causes its currency to fall.

Given that New Zealand has already broken out of COIVD19 induced lockdown measures the dovish tilt was surprising. So, we have to remember that there is possibility of a domestic improvement which negates the need for negative rates going forward.

 

Central Bank Divergence: RBA vs RBNZ

The Reserve Bank of Australia,  by contrast,  is less inclined to negative rates and does not favour them. So, we can therefore expect to see a divergence between the AUD and the NZD. Due to this situation the yield spread between the Australian and New Zealand 10 year bond will be set to widen. See the chart here from a Bloomberg piece on this yesterday showing the yield spread difference between the tow 10 year bonds (white line). Notice how the AUDNZD pair follows the spread between the two bonds:

Chart

Therefore, look for pullbacks on the AUDNZD pair and expect buyers to enter around the 1.0700 handle as long as this central bank divergence remains.


 

Learn more about HYCM

 

High Risk Investment Warning: Contracts for Difference (‘CFDs’) are complex financial products that are traded on margin. Trading CFDs carries a high degree of risk. It is possible to lose all your capital. These products may not be suitable for everyone and you should ensure that you understand the risks involved. Seek independent expert advice if necessary and speculate only with funds that you can afford to lose. Please think carefully whether such trading suits you, taking into consideration all the relevant circumstances as well as your personal resources. We do not recommend clients posting their entire account balance to meet margin requirements. Clients can minimise their level of exposure by requesting a change in leverage limit. For more information please refer to HYCM’s Risk Disclosure.

Analysis feed

FXStreet Trading Signals now available!

Access to real-time signals, community and guidance now!


Latest Forex Analysis

Editors’ Picks

EUR/USD chops around amid end-of-month flows, ahead of Trump

EUR/USD is battling 1.11, close to the two-month highs amid choppy trading. Hopes for a fiscal boost in Europe and mixed satisfactory data have supported the currency pair. , Sino-American tensions are rising and investors await President Trump's China announcement.

EUR/USD News

GBP/USD advances amid US dollar weakness, shrugging off concerns

GBP/USD is trading above 1.23, edging higher amid US dollar weakness and Britain's gradual reopening. Intensifying Sino-American tensions and the Brexit impasse are ignored. 

GBP/USD News

Cryptocurrencies: $348M in matured derivatives boost the market

Futures and options contracts' expiration brings a wave of volatility to the crypto market. Ethereum takes advantage and attacks resistances in the market dominance chart, Bitcoin goes back. Ripple disappoints despite regaining the third place in market capitalization.

Read more

Canada's economy falls by 8.2% annualized in Q1, better than expected, USD/CAD shakes

The Canadian economy squeezed by an annualized rate of 8.2% in the first quarter of 2020, better than -10% expected. Quarterly, Gross Domestic Product (GDP) squeezed by 2.1%. Most of the downfall occurred in March, with a drop of 7.2%, better than 8.5% projected. 

Read more

WTI drops 4% and eyes $32 mark amid risk-off, weakening demand

The selling pressure around WTI (July futures on Nymex) accelerates following the break below the 33 level, as bears now target the 32 support zone heading into the key US macro data and US President Donald Trump’s response to the Hong Kong issue.

Oil News

Forex Majors

Cryptocurrencies

Signatures