NZD/USD carving its own path before RBNZ rate decision, US inflation report

• NZD/USD has not been particularly correlated with anything recently
• Price signals may therefore be more influential than moves in other markets
• Markets favour a rate cut from the RBNZ on Wednesday
• US CPI, retail sales reports are key events for traders this week

Wild Wednesday looms

This week looms as an important one for NZD/USD, reaching its crescendo on Wednesday when the RBNZ delivers its August monetary policy decision hours before key inflation data arrives in the United States. Given the Kiwi has been dancing to its own turn recently, it suggests directional moves driven by these events may have legs over the coming days.

NZD/USD carving its own path

It wasn’t that long ago the Kiwi was being treated by traders as a proxy for Chinese economic concerns, often moving in the same direction as other China-linked markets such as Hang Seng and copper futures along with the offshore-traded yuan. But those correlation have fallen apart recently. When you look at the daily chart below, NZD/USD hasn’t had particularly strong relationships with Chinese markets, domestic interest rates or riskier asset classes over the past month. Even its usual rock-solid correlation with the Aussie dollar has been weakening.

With the Kiwi moving independently of other markets, traders may want to put more emphasis on price signals this week. The lack of strong correlations also suggests that if we see a big initial reaction to risk events, they may remain influential on NZD/USD beyond the short-term.

Event risk rising

Looking at the events calendar this week, three events stand out as being particularly important for NZD/USD: the RBNZ rate decision, US CPI and US retail sales.

RBNZ rates decision not clear cut

When it comes to the Reserve Bank of New Zealand (RBNZ), markets marginally favour it to reduce rates for the first time since the pandemic, putting the probability of a 25 basis point reduction to the cash rate to 5.25% at just over 60%.

I’m with the majority after the RBNZ’s dovish pivot in June with data received since likely to bolster its confidence that inflation will return to its 1-3% target range by year-end. While domestic price pressures remain prevalent, it’s largely in categories that monetary policy is unable to influence. With slack in the labour market building quickly and inflation expectations two-years out already back at the midpoint of the RBNZ target, it comes across as the appropriate time to focus on downside risks for the inflation outlook given monetary policy works with a lag.

While the initial NZD/USD reaction is likely to reflect the rate decision, the more influential factor will likely be what the RBNZ signals regarding the rates outlook in its forecast track and in the tone of the policy statement. Will it be coy towards future cuts like other central banks have been or will it signal a preparedness to continue easing?

My calculated guess is it will give a dovish message conditional on no nasty upside surprises in incoming inflation data. One look at the New Zealand economy shows monetary policy is very restrictive, so why keep it there exacerbating the risk it may have to cut aggressively in the future? But the RBNZ is known delivering surprises, so prepare for anything.

Just to add to the risk of volatility, Governor Adrian Orr will deliver a press conference following the decision along with more media engagements on Thursday.

US CPI, retail sales loom as important

For Wednesday’s consumer price inflation (CPI) report, markets look for the core measure to lift 0.2% in July following a 0.1% gain in June, leaving the increase on a year earlier at 3.2%. While markets seem to be placing more emphasis on activity data rather than inflation right now, this report remains important as it carries the ability to influence economic sentiment. If too cold, it may raise concerns that demand is diminishing quickly. But if it comes out hot, it may spark a collective rethink on the scale of rate cuts that have already been factored in, similar to what was seen earlier this year.

Thursday’s retail sales report is also easier to interpret, with a big undershoot on expectations for a 0.3% increase in headline and 0.2% lift in core likely to spark renewed concerns about the outlook for the economy.

For NZD/USD, the greatest fuel for downside would likely come from a dovish RBNZ, extremely weak CPI report and miss in retail sales. For upside, a non-move or hawkish cut from the RBNZ, along with CPI and retail sales prints not too dissimilar to forecast, comes across an ideal scenario.

NZD/USD remains respectful of levels

On the daily, the rebound in NZD/USD from the lows hit on Monday has stalled in recent days, perhaps reflecting the proximity to downtrend resistance dating back to the highs set in June. I feel confident saying this given how respectful the Kiwi has been of existing levels over the past few months. If I’m on the money, it suggests that if we see an interaction with the downtrend this week, the subsequent reaction may provide clues on medium-term directional risks.

On the topside, resistance is noted around .6050, .6150 and .6218. On the downside, .5985 and .5860 are levels to watch.

-- Written by David Scutt

Follow David on Twitter @scutty