0.5550 area: New Zealand Dollar holds steady as US Dollar bulls pause

0.5550: NZD/USD steadies as the retreat from the 0.5650 area slows.
With an October quarter-point Fed rate increase priced in, the US Dollar pauses.
Kiwi gains are likely to remain capped as Fed-RBNZ policy paths diverge further.

NZD/USD is little changed around 0.5550 on Thursday. The New Zealand Dollar (NZD) is retaining its losses against the US Dollar (USD) following the past two days’ retreat. After another rejection around 0.5650, the pair lacks direction near the bottom of its four-week trading range, a short distance from the year-to-date low of 0.5527.

TMGM Analysis: Financial Market News, Economic Calendar & Market Insights

Tuesday’s hot US Consumer Price Index (CPI) readings have helped the Greenback outperform its peers this week. The figures strengthened expectations that the Federal Reserve (Fed) will raise interest rates by at least a quarter point at its December meeting.

That outlook has received backing from Fed officials, whose hawkish message is likely to be repeated later on Thursday. Several US central bank policymakers are due to make public appearances during the day. Some have already voiced concerns over elevated price pressures and supported additional monetary tightening in December.

USD rally: BBH warns "The USD might have run too far, too fast"

A note of caution comes from Brown Brothers Harriman’s Elias Haddad, who warns that “the USD rally may have run too far, too fast.” In his assessment, “USD has overshot the level implied by rate differentials, limiting the scope for further gains in the near-term.”

Expectations for a “jumbo 50bps fed funds rate hike in December” are also likely to moderate, Haddad argues. He says they “will likely be constrained by stagnant US real wages and the resulting headwind to consumption spending,” pointing to the possibility of some USD repositioning over the coming days.

A narrow win for the centre-right ruling coalition in last weekend’s election eased fears of prolonged political uncertainty, giving the New Zealand Dollar some support at the start of the week. The boost did not reverse the currency’s downtrend, however. That decline began when the Reserve Bank of New Zealand unexpectedly left interest rates unchanged in late October.

As a net crude importer, New Zealand benefits from some economic relief when oil prices fall. Cheaper oil nevertheless also gives RBNZ doves grounds to leave rates unchanged, further widening the monetary policy gap with the Fed.

RBNZ: Key questions answered

Reserve Bank of New Zealand: What is its role?

New Zealand’s central bank is the Reserve Bank of New Zealand (RBNZ). Its economic mandate combines achieving and preserving price stability with supporting maximum sustainable employment. Price stability is achieved when inflation, as measured by the Consumer Price Index (CPI), is within the 1% to 3% band.

New Zealand Dollar: How does RBNZ monetary policy affect it?

Setting the Official Cash Rate (OCR) at a level consistent with its objectives is the responsibility of the Reserve Bank of New Zealand’s (RBNZ) Monetary Policy Committee (MPC). To bring above-target inflation under control, the bank raises its key OCR. This increases borrowing costs for households and businesses, slowing economic activity. The resulting higher yields generally support the New Zealand Dollar (NZD) by making the country more attractive to investors. Lower interest rates, by contrast, tend to put pressure on NZD.

Employment: Why does it matter to the RBNZ?

A tight labour market can add to inflation, making employment a key consideration for the Reserve Bank of New Zealand (RBNZ). Its objective of “maximum sustainable employment” means the highest level of labour resource utilisation that can be maintained over time without accelerating inflation. The bank explains: “When employment is at its maximum sustainable level, there will be low and stable inflation. However, if employment is above the maximum sustainable level for too long, it will eventually cause prices to rise more and more quickly, requiring the MPC to raise interest rates to keep inflation under control,”

Quantitative Easing (QE): How does it work?

Quantitative Easing is a monetary policy tool available to the Reserve Bank of New Zealand (RBNZ) in extreme circumstances. Under QE, the RBNZ prints domestic currency to purchase assets, typically government or corporate bonds, from banks and other financial institutions. The aim is to expand the domestic money supply and stimulate economic activity. A weaker New Zealand Dollar (NZD) is the usual outcome. The tool is a last resort when interest rate cuts alone are unlikely to meet the central bank’s objectives. The RBNZ deployed QE during the Covid-19 pandemic.