NZD Declared a ‘Buy’ by HSBC on Expectations That Interest Rates Will Rise Next Year

NZD Declared a ‘Buy’ by HSBC on Expectations That Interest Rates Will Rise Next Year

 Published: June 25th, 2021

The New Zealand dollar will benefit from increasingly hawkish market expectations over the coming months for Reserve Bank of New Zealand (RBNZ) monetary policy, that the opinion of senior currency analysts at HSBC and Sydney-based Westpac. They think interest rates could start rising as soon as Q2 of 2022 and say a growing number of bellwether investors are beginning to make wagers on that basis.

Pricing in some markets suggests a growing optimism amongst forex traders and investors on the outlook for borrowing costs in New Zealand, where there’s been a visible build-up of hawkish sentiment since the central bank’s May policy meeting, where it presented assumptions about future interest rates for the first time since the start of the pandemic.

Included in that was an assumption that New Zealand’s 0.25 per cent official cash rate would rise 0.5 per cent in Q3 of next year. If enough forex traders make bets on that likelihood, it could mean a rate lift-off happens even sooner.

The kiwi has been slow to close a persistent performance gap with the other currencies benefitting from renewed optimism in recent months. That prompted a deeper analysis of the situation, HSBC says.

‘An out-sized reaction by USD to what has really been just an incremental shift in tone from the Fed will likely reverse in the coming weeks,’ said HSBC’s head of FX research in a recent client briefing.

‘Our view is that the best approach is to assume a USD reversal would be weaker against NZD. The kiwi looks cheap now in the context of a shift in rate expectations. While the RBNZ is sounding a hawkish tone, this may not have been completely priced in to currency prices yet.’

On that basis, HSBC says NZD is a 'buy'

HSBC told the bank’s clients this week they were recommending a buy for NZD/USD at the 0.6969 level, with expectations of a move up to 0.7288 in the short term. HSBC said the RBNZ’s new attitude and current forecasts based on a coming reversal in USD strength validate the market’s response to date.

A majority of the Fed's rate-setters have said that they expect to vote for a lift in US rates by the end of 2023. A notable minority on the Fed’s FOMC (Federal Open Market Committee) see a possible case for a move in 2022. However, Fed Chair Powell played down the likelihood of that happening when he spoke to journalists at a recent Washington press conference.

‘We’re watching for USD weakness in the next few months,’ HSBC says. ‘The greenback’s sharp response to shifting FOMC sentiment regarding a rate rise was reflected in our USD speculative flow data. We expect the tone from the Fed to remain patient and counter the market’s more hawkish reflexes.’

The near-term outlook depends primarily on whether or not markets called it right in assuming last Wednesday’s Fed update means risks to the Fed’s inflation target are real and pressing enough to warrant speculation about an interest rate rise. If there is a renewed decline in USD, the kiwi could be one of the first to benefit from it.

Waiting for the recovery to bed in

There’s a lot in the bank’s analysis and expectations for RBNZ interest-rate policy that hinges on the recovery still underway in the New Zealand economy. Economic data will influence the kiwi dollar, but only time will tell if it’s enough to lift inflation back above the two per cent midpoint of the central bank’s one- to three per cent target. Recovery has to bed in firmly in order to hit that target sustainably in the coming years.

Analysts at Westpac, however, have a somewhat different view.

‘We’re looking for the RBNZ to start lifting the OCR from July of 2022,’ Westpac’s currency strategy unit said in a research briefing this week.

‘While we previously thought any interest rate hikes would be delayed until mid-2024. There are now indications of solid growth in domestic demand. We’re more confident now that New Zealand’s economy can hold up in the face of a gradual return to normalised monetary policy.’

Westpac's view is obviously worth noting, but its stance is particularly interesting given it also said that's its sudden change of heart 'isn't motivated by inflation concerns.’ It's lifted forecasts to reflect the new expectation that New Zealand’s rates will see a rise next year rather than later.

It’s inflation that central bankers seek to manage when they alter interest rates up and down or use mechanisms like quantitative easing to influence currency valuations or create liquidity. In most cases, a central bank will see rising inflation as a potential problem for the economy, especially if it leads rate-setters to start raising borrowing costs. Business growth, in that case, becomes weighed down by higher expenses.

Westpac analysts believe there’s a rising chance that the RBNZ will push up its cash rate slightly next year as long as inflation pressures remain contained. If that happens, it will indicate that the central bank's policymakers are setting up for a future where they may need to act in order to reduce borrowing costs again if a new crisis lands.

In normal times, central banks would avoid that kind of action. However, with treasuries around the world (New Zealand included) still pumping a significant percentage of GDP into fiscal support programmes, it could be that some like the RBNZ could go down that policy route in order to fight off the adverse impacts of economic stimulus.

Westpac analysts say the RBNZ likely has ‘time on its side’ to manage inflationary pressures. The bank is forecasting an NZD/USD rally to 0.73 by the end of this year, seeing little evidence of overheating in New Zealand’s economy.

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