Potential RBNZ dovish pivot no guarantee to deliver NZD/USD weakness

• New Zealand remains in recession
• Latest data suggests the downturn is getting worse, adding to RBNZ rate cut bets
• Relative central bank rate expectations have been influential on NZD/USD
• Nature of Fed’s looming easing cycle likely to determine NZD/USD longer-term trajectory

NZD/USD quick take

The Reserve Bank of New Zealand (RBNZ) continues to sacrifice its domestic economy to defeat inflation, but how much longer than continues is debatable given how rapidly conditions are deteriorating. The May BusinessNZ Performance of Services Index (PSI) made for grim reading, pointing to the likelihood of New Zealand’s recession extending even further.

Markets are alert to the risk of the RBNZ pivoting, dragging NZD/USD lower on Monday. But when it comes to directional risks for the Kiwi beyond the short-term, it really comes down to the US interest rate outlook and health of the global economy.

New Zealand recession getting worse?

Mirroring so many other economic indicators in New Zealand recently, the latest BusinessNZ PSI was horrendous, hitting the weakest level on record outside of pandemic disruptions.

At 43.0, the May reading suggests activity continued to decline sharply, fitting with an economy already in recession. The weakness was most acute around North Island which just happens to be New Zealand's centre of economic activity. Every indicator softened with readings on sales, new orders and inventories particularly ugly. Employment continued to fall.

Source: Antipodean Macro

“The speed of decline is as worrisome as its size over the past three months. There is weak and then there is very weak. Overall, this tells of a services sector in reverse, at pace,” said BNZ’s Senior Economist Doug Steel.

Separate data released Monday was equally as troubling with New Zealand’s median house price tumbling 3.1% in May, according to the Real Estate Institute of New Zealand, leaving prices down 1.2% on a year earlier.

Kiwi swaps rush to price in rate cut risks

Given the recessionary data signals, it comes as no surprise that markets are piling on RBNZ rate cuts bets again with New Zealand two-year interest rate swaps down 30 basis points from levels seen earlier this month. Two-years swaps are the market instrument most New Zealand mortgagers are priced off.

Source: Refinitiv 

As rate cut bets have swelled over the past week NZD/USD has come under pressure, seeing the pair move back towards the bottom of its recent range. Momentum indicators are pointing firmly lower, mirroring the price action, while the correlation between New Zealand-US two-year yield spreads over the past month has strengthened, signaling relative central bank interest rate expectations are increasingly influential.

NZD/USD range trade favoured… for now

For the moment, range trading in NZD/USD is preferred over the adoption of a bearish bias given heightened uncertainty over the US interest rate outlook and what will eventually trigger the Fed’s first cut.

Buying dips through .6100 with a stop below .6083 is one option when the price nears the bottom of the range, allowing for longs to target resistance above .6200. The trade can be flipped when NZD/USD ventures towards the top of the range, with shorts initiated on moves to .6200 with a stop above .6220 for protection.

Nature of Fed easing cycle key to long-term directional risks

Beyond the short-term, directional risks for NZD/USD are likely to be determined by what circumstances the Fed begins to cut interest rates under. Should it be due to a continued easing in inflationary pressures, there’s every chance NZD/USD will push higher. But if it’s forced to cut due to a rapid deterioration in the US economy, the spillover effects to broader cyclical assets will be detrimental, pointing to downside risks.

-- Written by David Scutt

Follow David on Twitter @scutty