How to Trade the NZD Rate Decision

06/08/2011 5:00 am EST

Focus: FOREX

New Zealand’s central bank is expected to leave rates on hold today, but comments about the economy and future monetary policy could create tradable moves in NZD/USD. Here’s how to play it.

The Reserve Bank of New Zealand (RBNZ) is announcing their interest rate decision today (Wednesday) and is anticipated to keep the cash rate on hold at 2.50% in June. Currency traders are likely to show a bearish reaction to the decision, as the central bank looks to carry its “wait-and-see” approach into the second half of the year.

View economic calendar here

According to Credit Suisse overnight index swaps, investors are pricing a zero-percent chance for a 25-basis-point rate hike this month, and RBNZ governor Alan Bollard may continue to talk down speculation for higher borrowing costs as the region copes with the aftermath of the Christchurch earthquake from earlier this year.

As the NZD/USD pares the advance from May, dovish comments from the central bank are likely to exacerbate the reversal from 0.8262, and the exchange rate may threaten the upward trend from March as interest rate expectations deteriorate.

chart
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The expansion in production paired with the ongoing rise in employment certainly reinforces an improved outlook for future growth, and the RBNZ may raise its economic assessment for the region as private sector activity gathers pace.

However, as households and businesses cope with the aftermath of the earthquake from earlier this year, the slowdown in price growth may lead the RBNZ to support the real economy throughout the remainder of the year, and the central bank may see scope to keep the benchmark interest rate on hold beyond 2011 in an effort to encourage a sustainable recovery.

In turn, the NZD/USD may continue to retrace the advance from back in March and the exchange rate may work its way back towards former resistance around 0.7800 as the pair searches for support.

Potential price targets for the rate decision are marked in the chart below by the horizontal lines at 0.78900 and 0.83000:

chart
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NEXT: How to Trade This Event Risk

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How to Trade This Event Risk

With the RBNZ set to keep the benchmark interest rate on hold at 2.50%, trading the given event risk is certainly not as clear cut as some of our previous trades, but hawkish comments following the rate decision could pave the way for a long New Zealand dollar trade as investors weigh the outlook for future policy.

Therefore, if the RBNZ raises its economic outlook for the region and sees scope to tighten monetary policy in the second half of the year, we will need to see a green, five-minute candle subsequent to the decision to generate a buy entry on two lots of NZD/USD.

Once these conditions are met, we will set the initial stop at the nearby swing low or a reasonable distance from the entry, and this risk will establish our first objective. The second target will be based on discretion, and we will move the stop on the second lot to cost once the first trade reaches its mark in an effort to lock in our winning.

In contrast, the RBNZ may look to support the real economy throughout the coming months as the fundamental outlook remains clouded with high uncertainty, and the central bank may continue to talk down speculation for higher interest rates in order to stimulate growth.

As a result, if governor Bollard maintains a dovish tone for monetary policy, we will carry out the same strategy for a short NZD/USD trade as the long position set out above, just in reverse.

chart
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At last April’s decision, the RBNZ held the benchmark interest rate at 2.50% in April given the uncertainties surrounding the economic outlook and went on to say that monetary policy is likely to “remain appropriate for some time” as the region copes with the natural disasters from earlier this year. At the same time, RBNZ Governor Alan Bollard noted that the marked appreciation in the local currency is “unwelcome” as policymakers aim to encourage an export-led recovery, and talked down the risk for inflation as he expects price growth to “settle comfortably” within the 1%-3% percent target range over the near term.

The balanced tone held by Mr. Bollard suggests that the RBNZ will keep the benchmark interest rate on hold in the coming months, and the central bank may look to carry its “wait-and-see” approach into the second half of the year as it aims to strengthen the real economy.

Indeed, the New Zealand dollar struggled to hold its ground following the April rate decision, with NZD/USD slipping to 0.8006, but the high-yielding currency recouped some of the losses during the day as the exchange rate closed at 0.8020.

Price reaction from last April’s decision:

Chart4

By David Song of DailyFX.com

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