Will RBNZ Halt NZD Rally?

Today's rally marked the sixth consecutive day of strength for the New Zealand dollar. In the short span of a few days, NZD/USD has risen from a low of .6490 to a high above .6650. Broad based US dollar weakness played a big role in the move but the New Zealand dollar has been one of the strongest currencies because its gains were validated by better than expected economic data. Last night, we learned that while the country's trade surplus narrowed, the balance fell less than expected and more importantly, exports and imports increased in the month of May. In fact exports hit a record high of NZ$5.8B on the back of strong demand for milk powder and infant formula. Milk powder exports rose 32% while food preparations, which included infant formula rose 41%. China's economy may be slowing but the Chinese are not cutting back on what they now see as essentials - butter, milk, and high quality baby formula. Data such as this will play a big role in tonight's Reserve Bank monetary policy announcement.

The Reserve Bank of New Zealand's monetary policy decision is right around the corner and many investors are wondering if the central bank will put a halt to NZD/USD's rally. The currency pair's price action suggests that the market is looking for less and not more dovishness but everyone's concerns about slower global growth should be the RBNZ's as well. The last time they met, the RBNZ cut interest rates by 25bp. The decision took NZD/USD to a 6 month low but the drop was short-lived because the central bank suggested they are one and done. Since then we haven't seen a clear trend in New Zealand's economy. The latest GDP numbers were strong and service sector activity is up. Manufacturing activity, inflation and spending are lower but that may not be enough to convince the RBNZ that another rate cut is needed. There is no doubt that the global economy is weakening and it would be remiss for the RBNZ not to express concerns but how the New Zealand dollar responds will depend on how aggressive the RBNZ thinks they need to be about easing. If they feel that another preventive rate cut is needed, NZD/USD will reverse its gains quickly but if they leave most of their policy statement unchanged NZD/USD could break 67 cents easily.

Meanwhile even though euro, sterling, Swiss Franc and the Canadian dollars pulled back, US dollar bears are in control. The latest economic reports reinforce the case for easing. House prices stagnated in the month of April, new home sales dropped -7.8%, the largest single month decline since November and the consumer confidence index dropped 10 points! All of this shows that low rates and equity market gains are not enough. So while Fed President Bullard said the situation doesn't call for a 50bp rate cut, "it seems like a good time for an insurance rate cut." According to Fed Chair Powell who also spoke today, the central bank is closely monitoring incoming data and weighing the uncertainties. The case for easing has strengthened because trade concerns are up substantially and the inflation undershoot may be more persistent than they hoped. The fact that he said today's message is intended to be consistent with the FOMC press conference is a sign that the dollar should be trading lower and not higher following the release. USD/JPY dropped below 107 for the first time in 6 months and while it ended the day above this level, we believe that another move below it is inevitable.