The New Zealand dollar remains under pressure since last week’s sell-off, when the Reserve Bank surprised the market by suggesting that a 5.5 per cent official cash rate (OCR) will be the peak.
At about 60.3US cents, the currency is still more than 2USc down from its levels before the bank’s monetary policy statement (MPS), which accompanied the interest rate decision.
And it could be heading further south yet if local yields continue to fall and overseas rates continue to rise.
Like the currency, wholesale interest rates have stayed lower after the Reserve Bank dropped its bombshell last Wednesday – prompting one of the most volatile trading days of the year.
But while wholesale interest rates have shifted sharply lower - the two-year swap rate is at 5.20 per cent, from 5.55 pre-MPS - some market economists remain sceptical that an OCR of 5.50 per cent will be the peak.
Likewise, market pricing still suggests there is a 50/50 chance of another hike around August or October this year.
ANZ and Westpac economists say there is one rate hike left, which would take the OCR to 5.75 per cent.
The sharp fall in the kiwi – which enjoys a strong reputation as a so-called “carry” trade, offering superior interest rates relative to its peers – came as a rude shock.
ANZ strategist David Croy said the surprisingly “dovish” tone of the Reserve Bank’s monetary policy statement caught markets by surprise, hence the sharp reaction.
“While everyone expected a hike, the market was split as to whether they would go by 25 or 50,” Croy said.
“But what really set interest rates off to the downside was the fact that – subject to their projections standing up – the Reserve Bank wanted to pause at 5.5 per cent immediately.”
In the lead-up to the MPS, markets had priced in a peak OCR of 5.9 per cent.
That has now come back to 5.6 per cent.
“Essentially, about 40 basis points of ‘carry’ was taken off the table, and I suppose the Reserve Bank’s comment that the economy was starting to slow also weighed a bit on market sentiment,” he said.
Croy doesn’t expect the NZ dollar to stay down for long.
“New Zealand has the highest rate of interest across the G10 countries – and a positive interest rate differential with the United States,” he said.
But ASB economist Mark Smith said with New Zealand yields falling and overseas yields rising, the kiwi could end up swimming against the tide.
“Normally, when risk appetite improves you would see the kiwi do well.
“But what we have seen is a reassessment of interest rates, and a narrowing of interest rate differentials [with the rest of the world].”
Currencies shift on interest rate differentials and on that score, the Kiwi-Aussie cross rate has already fallen to A92.5c from 94.5c before the MPS.
Harbour Asset Management fixed-income and currency strategist Hamish Pepper said pricing in interest rates showed that market had not abandoned the idea of another rate hike.
“The market has not completely given up on the thesis that fiscal spending, and the front-loaded nature of it, would be something that would require the Reserve Bank to do more.
“The market also does not go along with the idea that the impact of immigration would be ambiguous for inflation, because it can impact on both supply and demand,” he said.
“For me, I think the Reserve Bank has been pretty clear.
“They have really finished here, and they will be watching, waiting and worrying, and that process takes time.”
Pepper said the kiwi’s day’s days In the sun as a highly sought-after carry trade may be numbered.
“The outlook now is that New Zealand yields, relative to the rest of the world’s, are going to decline,” he said.
In addition, there were concerns about New Zealand’s current account deficit, which approached 9 per cent in the March year, and generally high levels of public and private debt.
“And that’s something that is not usually supportive for the currency.”