New Zealand Dollar: NZD/USD (NZD=X) Expanded QE, but more to come
Last week saw three big developments. The country took an enormous step
towards normality by moving into Alert Level 2; the RBNZ at its Monetary Policy Statement scaled up QE to $60bn and left all other tools on the table; and the Government delivered a truly massive Budget, featuring a big public housing build, a targeted extension of the wage subsidy program, and a big ramp-up in health spending – and more to come, with a lot of funding as yet unallocated.
We are now forecasting a further scaling-up of QE at the August MPS to a $90bn limit. This will help to absorb the bigger-than-expected program of Government bond issuance to fund all that spending. The RBNZ has received an indemnity from the Government to increase QE as outstanding bonds grow, so the hurdle has been lowered, but an expansion will still need sign-off from the Monetary Policy Committee. We expect this will happen at the August MPS, if not earlier.
Last week’s Budget flagged significantly more bond issuance than we and the market were expecting. Future issuance is based on forecasts that have
conservative buffers built in, but the market still has to absorb it all. The RBNZ’s newly increased QE programme doesn’t quite have the capacity to absorb all of next year’s issuance, but it could if it were increased, as we expect it to be (probably in August).
Keeping the NZGB curve low and flat remains a priority for the RBNZ and it remains a key element in our forecasts. The threat of a negative OCR (next year) and potential QE purchases of foreign assets are significant headwinds for the NZD, as is the very real potential for a real souring of risk appetite as global data continues to shock to the downside.
Chart of the Week
We expect the Reserve Bank’s LSAP (QE) programme to be expanded to $90bn at the August Monetary Policy Statement to head off any upward pressure on the yield curve from the Government’s expanded debt issuance program.
Global Dairy Trade auction
(Wednesday 20 May, early am). There are mixed pricing signals across commodities and delivery periods but overall prices are expected to tick down again by about 2.5%. Offerings of whole milk powder for delivery in June and July have increased, signalling some combination of a smaller impact from the drought on milk supply, a push to sell more product while prices are still strong, and/or a desire to minimise stocks at balance date.
Food Price Index – April
(Wednesday 20 May, 10:45am). Food prices are usually pretty stable in April. But this April will be different. Grocery prices were likely a little stronger than usual, while restaurant meals were not traded at all. Stats NZ has had to impute some prices. It’ll take another month or two for the dust to settle.
ANZ Monthly Inflation Gauge – May (Wednesday 20 May, 1:00pm).
Retail Trade Survey – Q1
(Friday 22 May, 10:45am). Spending patterns were normal for most of Q1, but things started to change towards the end there. Some people stocked up on groceries and DIY materials ahead of the lockdown, but at the same time began to question their discretionary spending decisions as reality began to
set in that recession is looming. We’ve pencilled in a 0.2% q/q rise in sales volumes. Weakness in Q2 will be unprecedented.
Performance Services Index – April
(Monday 18 May, 10:30am). Like the Performance of Manufacturing Index, it’s not going to be pretty.
Shayne Heffernan Trade Idea
“Technical studies have turned bearish. Price action is below major moving averages and oscillators support weakness.
‘Bearish divergence’ on stochastics adds to the downside pressure. Scope for dip till 61.8% Fib at 0.5739.” Shayne Heffernan PhD in Economics
Why This Matters
Last week was rather busy on the macroeconomic front, one could say. New Zealand graduated into Alert Level 2, enabling many more retail and hospitality businesses to open in something resembling, if not quite, normality. The RBNZ at its Monetary Policy Statement scaled up its quantitative easing (QE) program as expected and struck a dovish tone, expressing its willingness to do more and keeping future options – including negative interest rates – on the table. Completing the trifecta for the week was the Government delivering an unprecedentedly large Budget in the face of the current COVID-19 crisis, with a much bigger bond issuance programme than expected to accompany it.
It was certainly a big week, but most of it was broadly in line with our expectations and in light of the giant uncertainty surrounding any macroeconomic forecast at the moment, none of it warrants a revision to our GDP growth forecasts. However, in light of the giant government bond issuance program unveiled at the Budget, we now expect the RBNZ’s QE programme to be scaled up to a limit of $90bn. This is in order to keep the yield curve low and flat, in order to keep debt-servicing costs low and provide further assistance to the economic recovery.
Expanded QE, but more to come
At the MPS last week the RBNZ roughly doubled its QE programme from $33bn to $60bn, as expected. Purchases will remain largely oriented to purchases of nominal New Zealand Government bonds (NZGBs), but will now also include a small amount of inflation-linked bonds, along with a small amount of bonds from the Local Government Funding Agency (LGFA).
In its Statement, the RBNZ made it clear that it is, unsurprisingly, worried about the economic outlook and potential downside risks, and that they are willing to do more to stimulate the economy. They noted that, “the LSAP programme can be scaled as needed in future,” and, “there are policy tools available that have not yet been used”.
They do have plenty of options available, and have left the door open for negative policy rates down the track, although both their forward guidance phrasing and their published OCR forecasts rule it out before March 2021. But for now, QE remains the tool of choice. At his appearance before the Finance and Expenditure Committee Governor Orr said that QE was easy, effective and had the least distortions. We agree that it is the right approach, for now at least.
The RBNZ expressed satisfaction regarding the effectiveness of their QE to date (see our FAQ for more on how QE works). Clear signalling of the RBNZ’s future asset purchases have had a clear impact on markets, with the currency lower, bond curves flatter, and lower across a range of outstanding bonds (figure 1).
However, the bond market now faces a challenge, with the Budget revealing a significantly larger amount of issuance than expected, particularly over the next 12 months (see Budget reflections, page 6). The need to absorb it all means a further ramp-up is likely, even though the QE program has only just been scaled up.
In the short term, the RBNZ may choose to front-load purchases with the current $60bn limit, if the upward pressure on yields seen after the Budget persists. They can also conduct purchases to assist with market functioning and soothe market concerns.
But by August, we expect the asset purchase programme to be expanded to $90bn. This would allow the RBNZ even greater flexibility to absorb issuance and keep the yield curve sustainably low and flat in order to support the economy (see FX/Rates section on page 10 for a fuller discussion). The RBNZ has expressed a strong willingness to do what it can, and we think they will remain cognisant of downside risks, as they were in
the MPS last week. We expect the expansion to happen at the August MPS, if not earlier. A Monetary Policy Statement release is a logical time to do it, alongside the release of economic forecasts, and also when the Monetary Policy Committee (MPC) is gathered. However, we have no doubt that the RBNZ would not hesitate to expand the programme earlier should the economic outlook deteriorate or financial conditions tighten materially. An OCR Review or even inter-meeting move is possible, especially if bond markets become dysfunctional. Such a change in policy stance now simply
requires sign off from the MPC, since the RBNZ is now indemnified by the Government to purchase up to 50% of outstanding nominal NZGBs and 30% of outstanding inflation-linked NZGBs. This cap is likely to have been considered the portion beyond which RBNZ purchases would start to distort the market.
On current bond issuance guidance, the eventual cap projected based on this indemnity is technically $86bn of NZGBs. However, LGFA issuance is part of the mix too. Our expectation of an expansion of QE to $90bn would be an upper bound for total purchases over time depending on what is necessary, and it has the advantage of providing extra flexibility. The RBNZ’s actual purchases would simply need to fall within the indemnity cap at any given point in time. Should $90bn exceed the existing caps for which they are indemnified, it would leave open the option of purchasing short-term US Treasury bonds with the remainder, thereby placing downward pressure on the NZD.
Significant stimulus, but this crisis is bigThe RBNZ’s estimates of stimulus provided to date is significant, but we think more makes sense, given the magnitude of the current crisis. At the MPS, the RBNZ estimated that the overall stance of monetary policy taking into account both conventional and unconventional tools was equivalent to an “unconstrained OCR” of -1.3% over the June quarter (figure 2).
The “unconstrained OCR” is a new concept, which the Reserve Bank said “demonstrates the broad level stimulus needed to achieve the Reserve Bank’s monetary policy objectives, much like the OCR projection demonstrated in the past”. A negative unconstrained OCR “does not necessarily represent a negative OCR” because the stimulus could also be generated by QE or other tools.
The unconstrained OCR is in practice similar to the notion of the Shadow Short Rate (SSR) that we have often referred to, which sat at -1.9% at the end of April. This is the OCR that would have resulted in the observed yield curve. However, the RBNZ will use a suite of measures to estimate the “unconstrained” OCR. They are expected to publish their suite of estimates soon, including conceptual differences between them.
The RBNZ’s projects the unconstrained OCR to drop to -2.4%, based on the stimulus that has been put in place to date. However, we think that even more stimulus will be required. The current “unconstrained” OCR projection shows a total drop of ~350bps – still shy of the 575bp drop in the OCR in the GFC, and this shock is bigger. It’s possible that even more stimulus is effectively delivered than shown here, with bond curves moving lower and flatter in anticipation of future purchases and as the risk of negative rates is being priced in. But the surge in coming bond issuance now reduces that risk, and could work against the RBNZ’s intentions of reducing broader debt-servicing costs. Erring towards providing even more stimulus makes sense.
We are working on a rule of thumb that $10bn of purchases is equivalent to a 50bp drop in the OCR, meaning that another $30bn expansion of the programme to $90bn could provide an additional 150bps of stimulus (see our FAQ for more details). The risk of too much monetary stimulus seems remote at this point, as downside risks certainly remain front of mind. That said, risks are not all one way, and nor has everything followed the
worst case scenario in the past month, with the virus in retreat, the lockdown at the shorter end of expectations, and New Zealand’s commodity prices holding up relatively well. The most important economic data continues to be whether we are seeing community transmission of COVID-19. So far so good, touch wood.
Local Data Watch
Overall, the bias in prices is: Downwards.
The projected upper bound is: 0.61.
The projected lower bound is: 0.57.
The projected closing price is: 0.59.
A white body occurred (because prices closed higher than they opened).
During the past 10 bars, there have been 5 white candles and 5 black candles. During the past 50 bars, there have been 26 white candles and 24 black candles for a net of 2 white candles.
Momentum is a general term used to describe the speed at which prices move over a given time period. Generally, changes in momentum tend to lead to changes in prices. This expert shows the current values of four popular momentum indicators.
One method of interpreting the Stochastic Oscillator is looking for overbought areas (above 80) and oversold areas (below 20). The Stochastic Oscillator is 13.8630. This is an oversold reading. However, a signal is not generated until the Oscillator crosses above 20 The last signal was a sell 11 period(s) ago.
Relative Strength Index (RSI)
The RSI shows overbought (above 70) and oversold (below 30) areas. The current value of the RSI is 42.33. This is not a topping or bottoming area. A buy or sell signal is generated when the RSI moves out of an overbought/oversold area. The last signal was a buy 38 period(s) ago.
Commodity Channel Index (CCI)
The CCI shows overbought (above 100) and oversold (below -100) areas. The current value of the CCI is -153.This is an oversold reading. However, a signal isn’t generated until the indicator crosses above -100. The last signal was a sell 5 period(s) ago.
The Moving Average Convergence/Divergence indicator (MACD) gives signals when it crosses its 9 period signal line. The last signal was a sell 3 period(s) ago.
Rex Takasugi – TD Profile
FOREX NZD= closed up 0.002 at 0.595. Volume was 78% below average (consolidating) and Bollinger Bands were 34% narrower than normal.
Open High Low Close Volume 0.594 0.596 0.592 0.595 10,162
Technical Outlook Short Term: Oversold Intermediate Term: Bearish Long Term: Bearish
Moving Averages: 10-period 50-period 200-period Close: 0.60 0.60 0.63 Volatility: 16 21 12 Volume: 43,432 55,664 36,967
Short-term traders should pay closer attention to buy/sell arrows while intermediate/long-term traders should place greater emphasis on the Bullish or Bearish trend reflected in the lower ribbon.
FOREX NZD= is currently 6.0% below its 200-period moving average and is in an downward trend. Volatility is high as compared to the average volatility over the last 10 periods.
Our volume indicators reflect volume flowing into and out of NZD= at a relatively equal pace (neutral). Our trend forecasting oscillators are currently bearish on NZD= and have had this outlook for the last 1 periods.
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