NZD/JPY: A Subtle Distinction

On 10 March, Reserve Bank of New Zealand’s Governor Graeme Wheeler surprised markets with an unexpected 25 basis point reduction in the overnight cash rate. The RBNZ seemed comfortable with the 2.50% OCR which had just recently been reduced at the 10 December meeting. Central bank statement are formulaic and always very carefully worded. Central banks face a ‘language dilemma’ : how to comply with the legal requirements of a modern advanced economy and at the same time to present policy in the most neutral way possible so as not to influence asset markets. Hence, policy statements are most often subtle if not outright cryptic. However, in hindsight, an attentive trader central will often be able to correlate previous words with future actions. So it begs a subtle question: did the RBNZ surprise markets, or were markets surprised by the RBNZ? There is a difference.

At the 10 September 2015 meeting, the RBNZ reduced the OCR rate by 25 basis points to 2.75%. The September 2015 rate cut was expectedi. It’s important to note the RBNZ reasoningii. The statement noted that “...Global economic growth remains moderate, but the outlook has been revised down due mainly to weaker activity in the developing economies... ...particularly in China and East Asia...” Indeed, growth in the Asia-Pacific region was trending lower following the scaling down of China growth model. The bank voiced concerns about commodity prices and market volatility. Having one of the highest OCR rates in the region, the rate reduction seemed prudent. However, there was one non-regional issue which concerned the RBNZ: “...The US economy continues to expand. Financial markets remain uncertain as to the timing and impact of an expected tightening in US monetary policy...” The statements also noted the stronger NZ economic sectors on which a strong Kiwi would have a negative effect: “...robust tourism, strong net immigration, the large pipeline of construction activity in Auckland and other regions, and, importantly, the lower interest rates and the depreciation of the New Zealand dollar...”
 
In December, the US Fed increased the benchmark overnight lendingiii rate by 25 basis points, hence temporarily removing uncertainty for the RBNZ (and others). At the next RBNZ meeting at which the governing board decided to maintain its policy rate, Governor Wheeler noted that “...In recent weeks there has been some easing in financial conditions, as the New Zealand dollar exchange rate and market interest rates have declined...” Clearly, the Fed action eased pressure on the RBNZ. However, Governor Wheeler did ‘hedge’ and noted that “...Some further policy easing may be required over the coming year to ensure that future average inflation settles near the middle of the target range...” 



On 14 March, the Bank of Japan had its own surprise for markets by introducing a negative interest rate on deposits on a top tier of excess deposits. The negative rate action was very measured, however as noted, markets read into statements and decisions and the BOJ action put traders ‘en garde’. Further, at the US Fed 17 March meeting, the tone of the Fed was far less aggressive that it had been at the December meeting. In particular, Chair Yellen noted at the post meeting press conference that, “...we considered it unlikely that economic conditions would warrant an increase in the target range for the federal funds rate for at least the next couple of FOMC meetings...” 

The RBNZ had certainly understood the logic. Should the Fed not increase until June, it would then need to increase three more times between July and December to maintain its previous announced ‘four increase 2016’ plan. Lastly, the Fed would avoid changing policy in an election year. This eliminates October and November. If they didn’t do something on 17 March, it would be a long wait until June and even longer until after the US elections. 

Hence, once again the RBNZ was facing the increased potential for a strengthening Kiwi: it couldn’t count on a Fed increase to create some weakness in the Kiwi for some time to come. There were increasing market expectations that the BOJ would go deeper into negative rates and the economic adjustment in China was far from complete. Further, the ECB was also expected to take some actions a few days following the 10 March RBNZ meeting. 

Governor Wheeler had left the door open for further rate reductions, precisely in case the RBNZ needed to defend its best performing economic sectors which depended on a weaker Kiwi, let alone the struggling dairy export industry. What choice did the RBNZ have? Indeed, at the 10 March meeting, the RBNZ decided to reduce the OCR another 25 basis points. 

Hence the logic demonstrates that markets should not have been surprised by the RBNZ, 10 March OCR reduction. Hence, it’s better form to say that markets were surprised by the RBNZ decision and not that the RBNZ surprised markets.

It’s often said that hindsight is 20/20. Admittedly, this is the case here. However, it does construct a similar pattern which traders might hedge by. After the RBNZ meeting, the ECB did follow up with a further increasing of its easing policy; Chinese authorities voiced concerns about excessive debt levels, the Fed resumed with conflicting comments and major New Zealand trade partner, Australia, still maintains a 2.00% OCR creating a 25 basis point carry for Kiwi.

Hence, it would be reasonable to expect that the probability for further a RBNZ rate reduction is at least at even odds to maintain policy. The RBNZ would likely reduce after the BOJ or ECB, not before. The Yen has remained stubbornly strong, hence, it would be no surprise to hear Governor Kuroda at the very least talk the Yen down. So it’s reasonable then to expect NZD/JPY to remain in a range of ¥74.00 support and ¥83.00 resistance.