By DailyFX – Thirteen out of fourteen economists surveyed by Bloomberg expect the Reserve Bank of New Zealand to lift the nations overnight cash rate… … for the first time since December 2005.

If the central bank tacks on the 25 basis points the official
consensus is calling for, it would bring the benchmark lending rate to a new record
high. Looking at the foundation underlying these expectations, it is clear that the
hawkish convictions of RBNZ Governor Alan Bollard and Finance Minister Michael
Cullen are fueling the outlook rather than fundamental data itself. In fact, the
typical bellwethers for policy making have actually fallen well within tolerable
levels. For inflation, the primary charge of the monetary policy group, the fourth
quarter consumer price gauge actually quoted a 2.6 percent annual rate well
within the central banks 2 to 3 percent tolerance band. At the same time, the
most recent growth number has fallen to lows not seen in seven years. Nonetheless,
comments made by Cullen and Bollard have drawn the hawks out of the woodworks. In
comments made after his last policy decision, RBNZ head Alan Bollard shirked
prevalent expectations for a dovish turn in rhetoric. Instead, the central banker
keyed on housing sector growth and relentless consumer spending (especially in the
face of a proposed tax cut before the general elections) as reason enough for
further caution. Putting the arguments for a hike or pass aside, the implications of
a hike in current market conditions may prove critical. Given the substantial carry
trade unwinding in the past two weeks, a rate hike from the leading high-yield
currency may balance the entire FX market.

Bonds – New Zealand 10-Year Government Bond Yields

New Zealand bond yields have fallen nearly 25 basis points since marking a high back
on January 30th. Recently though, heavy speculation of a possible rate hike from the
New Zealand monetary authority has clearly put in a stubborn floor. Support has been
called in at 5.79 with multiple daily lows. However, combined with the overall
declining trend over the past six weeks, it is clear that a direction must be chosen
in the wake of this key decision. If the market consensus pans out, a rally in
yields would not be hard to imagine. In fact, the last policy meeting on January
24th, led to an eventual 15 basis point rally in yields with the mere repetition of
up-to-then familiar rhetoric.

FX – NZD/JPY

The New Zealand dollar could be primed for a solid correction as the Reserve Bank of
New Zealand is widely anticipated to hike rates to 7.50 percent. Indeed, the NZDUSD
pair plunged more than 5 percent on the recent carry trade unwinding before meeting
resistance at the 0.6750 level while NZDJPY sustained greater losses of more than 9
percent before losing steam near 78.00. How far will the carry trade liquidation
extend? It may actually be over and monetary policy tightening by the RBNZ could be
the final nail in the coffin. In fact, with the countrys benchmark already at a
record high, interest rate differentials are certainly to the benefit of those
buying the New Zealand dollar, especially when using the NZDJPY pair to do so.
Furthermore, a bounce in Kiwi would likely expand across the FX markets and give
traders the impetus to move towards other high-yielding currencies, such as the
Australian dollar, and sell off low-yielders like the Japanese Yen and Swiss Franc.
However, if the RBNZ decides to leave rates on hold, the implications could be
disastrous for the prime carry-trade pairs as liquidation returns in full force.

Equities – NZX 50 FF Gross Index

Equities in New Zealand have fallen in line with global equities over the past week,
but the NZX 50 FF Gross Index has slipped below not only a multi-month trendline,
but below the 50-day SMA as well. Nevertheless, shares got a slight lift during the
most recent session, as most markets corrected mildly higher. Exporters led
advances, as a weaker New Zealand dollar makes products from the country more
attractive.

However, the stock index could be in for further declines as the RBNZ is anticipated
to raise rates 25 basis points to 7.50 percent. With the benchmark already at a
record high, equity traders may be weary of the implications of higher borrowing
costs, which would impact not only businesses, but consumers as well. Furthermore,
monetary policy tightening would likely give a lift to the New Zealand dollar, which
would put a dent in profits for exporters. In the end, there will be only one winner
amongst the asset classes and FX will likely win over equities as the New Zealand
dollar will be the sole beneficiary of higher interest rates.

Regards,

John Kicklighter
Forex Capital Markets
32 Old Slip, 10th Fl
New York, NY 10005
Email: jkicklighter@dailyfx.com

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