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Interest rates – it’s not what you do, it’s the way you do it

 

  • 2019 has seen a cycle of rate cuts as one central bank follows another towards even looser monetary policy.
  • The policy ensures that individual economies avoid being isolated or ‘out of tune’ with the rest of the global economy, but there are questions being asked about whether it helps central banks meet their objectives.
  • With interest rates heading downwards and even into negative territory, the process has become something of a race to the bottom – but with the added twist that those that get there last are actually the winners.

 

As the next round of global interest rate announcements come into view, it’s unclear if the ‘follow my leader’ approach is going to work. The Indian central bank has followed the crowd and cut rates when others cut rates. The Reserve Bank of New Zealand (RBNZ) has instead engaged in efforts to surprise the markets. By avoiding being predictable, the RBNZ has actually brought about currency stability.

 

First up – India 

The Reserve Bank of India (RBI) will announce its monetary policy decision on Thursday 5th December. The Monetary Policy Committee (MPC), which meets on a bi-monthly basis, has been tipped by analysts to cut repo rates by 25 basis points. Taking the rate below 5% (to 4.9%) would take the total cut in rates since January 2019 to 1.6%. In the markets, there is a feeling that the RBI’s focus on interest rate policy may mean that it is doubling down on its problems. India Todayreports:

“Excessive reliance on a single method often ends up ruining an entire plan… maintaining balance is essential.”

Source: India Today

The alternative – to take no action – would be incredibly unnerving for the markets as Indian GDP growth has posted very unsettling numbers within the last week. It’s widely touted that GDP growth of approximately 7.5% is required to maintain employment levels and promote social stability. The latest Quarter’s GDP growth rate was instead 4.5% – a six-year low. At the same time, inflation is creeping up. Retail inflation rose to 4.62% in October. This marks a 16-month-high watermark and has come about due to higher food prices. The non-food and heating elements of the CPI are actually in a deflationary cycle – the ‘core inflation’ metric is currently running at a seven-year low of 3.47%.

There is little demand for non-food items, yet price movements in food and heating staples are hard to manage due to the global nature of those markets. Using the term ‘stagflation’ can cause consternation among the investment community, but the Indian central bank is facing something of a dilemma. As the announcement time approaches, it may be noted by the RBI’s officers that the default, in 2019 at least, has been: if in doubt, cut rates in line with market expectations.

While the challenges facing the RBI are shared by central bankers across the globe, the central bank of New Zealand took a slightly more aggressive and proactive approach to the situation.

 

Kiwi

The RBNZ adjusts its official cash rate (OCR) seven times a year. The relatively low frequency of announcements may explain why the RBNZ made a hefty and market-surprising 50-basis-point cut when it met on 7th August. At meetings in September and November, the RBNZ held its nerve, and its rates, at 1.00% – the hope being that the firing of its ‘silver bullet’ might have brought about stability. The policy is in contrast to that adopted by the RBI, which might better be described as a ‘death by a thousand cuts.’ So far, the NZDUSD pair is showing a degree of stability, which suggests that the RBNZ made the right call by avoiding being predictable.

OCR decisions and current rate

Source: Reserve Bank of New Zealand

The monetary committee of the RBNZ is constantly faced with the NZDUSD ‘Kiwi’ being very popular among international traders. Due to quirks of the calendar, the next OCR announcement is not due until well into next year, on 12th February 2020.

It’s interesting to ask, to what extent do intermittent but more dramatic policy moves by the RBNZ benefit the New Zealand economy? If the effectiveness of the policy is being judged in terms of forex stability, then the answer is, quite well. The current NZDUSD rate, 0.6535, is within the range of the daily candle on the day prior to the 50-basis-point cut of 6th August – 0.65099-0.56866 – this despite the appetite for hot money to trade the Kiwi forex pair.

NZDUSD – Daily Candle – August 2018-December 2019

Source: MetaTrader

Since the rate cut of August, Kiwi has seen some weakness (to be expected) but then a rally from mid-November. The 50-basis-point cut didn’t derail the Kiwi – it jolted it.

Source: DailyFX

DailyFX technical analysis suggests that Kiwi may be about to form a reversal pattern. The IG Sentiment chart shows short positions being unwound in greater numbers over the last week, which offers a ‘contrarian’ sell signal, on the basis that bulls are in the ascendancy for now and, as is the way, the reversal and next move will be to the downside. At the current levels, the price is also touching the resistance line of an upward channel.

NZDUSD – Daily Candle – August 2018-December 2019

Source: MetaTrader

“We are seeing positioning dynamics unfold in NZD/USD. From a weekly and daily basis, net-short positioning in Kiwi is increasingly unwinding. This leaves about 43% of traders net long and the IGCS outlook bearish. If we continue to see this ratio increase, speaking to a greater share of traders attempting to pick the top in Kiwi Dollar, prices may see selling pressure.”

Source: DailyFX

Both the Indian and New Zealand economies are exposed to the whims of the global markets. By demonstrating some guile, the RBNZ has brought about stability by keeping traders on their toes. There are still trading opportunities to be found in the markets, but a sound understanding of the nature of the price volatility will help.