Articles
5 October 2021

FX Daily: RBNZ to start tightening

Overnight price action shows how markets remain prone to buying the dips in the dollar, and also how the spillover from the troubled Chinese property market is far from over. In the rest of G10, NZD may receive moderate support from the RBNZ first rate hike tonight, the EUR may remain unfussed by Lagarde caution, and GBP looks unreactive to Brexit risk.

USD: Only short-lived weakness

The dollar started the week on the back foot yesterday, failing to rise on yet another equity sell-off, and suffering from the OPEC+ decision to stick to gradual supply hikes (400k barrels/day) which sent oil prices (and oil-sensitive currencies) higher. As highlighted in yesterday’s FX Daily, we think markets will keep buying the dips in the dollar, and this is what appears to have happened overnight, as the greenback rebounded across the board.

Also contributing to some safe-haven demand was the news that another Chinese property developer, Fantasia, failed to repay $205mln of bonds on Monday, raising concerns that the troubles for the Chinese real estate sectors extend well beyond Evergrande. As a consequence, China’s dollar high-yield bond segment fell by approximately 4 cents today, the biggest drop since 2013, and is now being increasingly monitored as a benchmark of how widely the troubles in the real estate sector are spilling over into Chinese financial markets.

Ultimately, this is likely a remainder that the headwinds to risk sentiment stemming from China’s property sector are far from over. In FX, we think this will continue to provide reasons not to turn any bearish on the dollar, while the high-beta commodity currency segment may not move as one bloc as some currencies can count on some protection offered by soaring energy prices.

In this sense, the divergence between the two closest peers, AUD and NZD, is quite central this week, as both currencies are also dealing with domestic central bank decisions. The RBA announced policy this morning and, as largely expected, followed its previous pledge to keep its monetary tools unchanged until February. The Bank merely reiterated that it remains committed to offer support to the economy and that it does not expect conditions for tightening to be met before 2024. The RBNZ rate announcement is tonight, and we expect a 25bp hike: we discuss it more in detail in the NZD section below. The policy divergence between AUD and NZD may struggle to push AUD/NZD significantly lower in the near term considering that: a) AUD, unlike NZD, can benefit from the energy crunch narrative; b) positioning on AUD/NZD is heavily skewed to net-short territory.

Back to the dollar, we’ll look for some consolidation in the USD overnight rebound. On the data side, markets are expecting a lower ISM services read today, and any upside surprise may offer an extra bit of support to the dollar as it strengthens the case for Fed tapering, although jobs data later this week are set to play a much bigger role. DXY inched back above 94.00 this morning, and may remain above that level on the day.

EUR: Lagarde to keep it quiet

The main focus in the eurozone today will be on August PPI numbers along with ECB President Christine Lagarde’s speech at 1600 BST. There is undoubtedly an open question in markets on whether the ECB will start to acknowledge their current forecasts are underestimating inflation given the recent spikes in CPI. Recent ECB communication did not seem to point at any hawkish shift in this sense, and we doubt Lagarde will significantly diverge from such cautious tone.

Ultimately, this will keep offering no reasons for investors to turn any bullish on the euro, and any EUR/USD rally may continue to lose steam before reaching 1.1650 this week, as USD momentum remains solid.

Elsewhere, municipal elections in Italy yielded some good results for the pro-EU Democratic Party in some major Italian cities. This may have come to the support of the BTP market this morning. Italian elections are still a way off (Spring 2023), but this is likely a pro-market development.

GBP: No Brexit-related risk embedded in the pound

The pound rose in line with other G10 currencies yesterday, not particularly influenced by reports suggesting the UK is drafting a plan to replace the Northern Ireland Protocol. Article 16 of the NI Protocol allows either the UK or the EU to unilaterally suspend parts of the deal for “economic, societal or environmental” upheaval. Accordingly, the clause would allow the UK only to suspend the parts of the Protocol that cause a determined issue. What matters the most for the market is that this would likely generate new frictions between the UK and EU, which may well lead to legal action or trade-related retaliations by the Bloc.

For now, the pound does not seem to be factoring in any meaningful risk of trade tensions with the EU or geopolitical risk in general. Our short-term fair value model indicates there is currently no risk-premium in EUR/GBP: over the past few years, Brexit-related risks have caused multiple overvaluation spikes (between 2% and 6%) in the pair.

Similar to what we saw yesterday, we expect rallies in Cable to face increasing resistance around the 1.3600 mark, and risks in the short term appear skewed to the downside, in our view.

NZD: RBNZ to start hiking tonight

We think the Reserve Bank of New Zealand will start its tightening cycle tonight (announcement at 0200 BST), delivering a 25bp rate hike – as discussed in our RBNZ preview. The Bank surprised markets in August by keeping rates on hold as the meeting coincided with the announcement of a nationwide lockdown in the country. New Zealand still has to find its way out of the Delta variant outbreak as Auckland has entered another week of lockdown, but there are too many indications that the economy is running hot for the RBNZ to refrain from raising rates, in our view. Inflation (3.3%) is above target, and a tight labour market suggests higher prices may be quite persistent, housing prices are still dangerously high (up 27.8% YoY in September), and activity is well above the pre-pandemic level.

Markets are pricing an approximate 80% probability of a rate hike today, so NZD could receive some moderate support. The major risk is that the Bank hikes but signals a more cautious approach ahead, given the impact of recent lockdowns. This, however, is not our base case, as we think that policymakers will leave all options open when it comes to the timing and pace of additional tightening, adopting a more data-dependent approach. We think this can leave markets relatively confident that we’ll see another hike by year-end, ultimately offering a positive undercurrent to NZD.

At the same time, within the pool of commodity currencies, NZD is not on the positive side of the energy story (New Zealand’s exports are mainly food and agriculture), and is therefore likely to be less shielded than the likes of AUD, CAD, NOK from any more hits to global risk sentiment.

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