Thursday, July 2

Central Bank Watch: RBA, RBNZ, & BOC Interest Rate Expectations

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Central Bank Watch Overview:

  • As the global economy inches towards recovery, the Australian, Canadian, and New Zealand Dollars have seen significant gains as traders bet on a more robust growth environment in the coming months.
  • It’s still likely that the BOC, RBA, and RBNZ keep rates at these levels, augmented by extraordinary policy otherwise (e.g. quantitative easing (QE)), through 2020 and beyond, especially now that the Federal Reserve has signaled its willingness to keep rates low through 2022.
  • Retail trader positioningsuggests that the commodity currencies may still have gains ahead of them yet.

G10 Currencies’ Central Banks Embrace ZIRP, NIRP, & QE

There are early signs that the world’s developed economies are moving closer towards re-opening following The Great Lockdown, but that doesn’t mean uncertainty has disappeared from financial markets. A dour June Fed meeting press conference led by Fed Chair Jerome Powell hinted at a sluggish, drawn out recovery for the world’s largest economy, sapping risk appetite.

Forecasting that rates will remain low through 2022, the Federal Reserve has reinforced the case that that every single central bank associated with the eight major currencies covered by DailyFX will continue to hold their main interest rates at or near all-time lows.

And now, after already having embraced zero interest rate policies (ZIRP) and quantitative easing (QE), the discussion has shifted to even more extreme measures like negative interest rate policies (ZIRP), particularly around the Bank of England and the Reserve Bank of New Zealand.

We continue to draw our attention to the commodity currencies in particular, as even though the Australian, Canadian, and New Zealand Dollars no longer hold the relative yield advantage that defined ‘the carry trade,’ these currencies retain significant economic exposure to agriculture and base metals, making them prime vehicles for speculation around a rebound in global growth.

Bank of Canada Rate Cut Odds Ebb and Flow

The Bank of Canada produced a steady-as-she-goes rate decision in June, signaling a high degree of confidence in its ability to continue to deliver easing as needed to the world’s tenth largest. While the BOC has said that is willing to take more accommodative action, in the same vein as the new financial market stability mechanisms announced in April, the interest rate path seems closed off for the time being.

Bank of Canada Interest Rate Expectations (JUNE 11, 2020) (Table 1)

Central Bank Watch: RBA, RBNZ, & BOC Interest Rate Expectations

After the June BOC meeting, according to Canada overnight index swaps, rates markets think that the BOC is less likely to act again this year than they had previously: a 5% chance of a 25-bps rate cut, down from 15% ahead of the June BOC meeting. This is a further drop from where interest rate cut odds stood at the end of May, when OIS discounted a 55% chance of an additional 25-bps rate cut this year. As it were, the sharp rally by the Canadian Dollar in the past three weeks as coincided directly with a retracement in interest rate cut odds.

IG Client Sentiment Index: USD/CAD Rate Forecast (JUNE 11, 2020) (Chart 1)

Central Bank Watch: RBA, RBNZ, & BOC Interest Rate Expectations

USD/CAD: Retail trader data shows 67.15% of traders are net-long with the ratio of traders long to short at 2.04 to 1. The number of traders net-long is 11.38% lower than yesterday and 10.70% lower from last week, while the number of traders net-short is 8.87% lower than yesterday and 12.85% lower from last week.

We typically take a contrarian view to crowd sentiment, and the fact traders are net-long suggests USD/CAD prices may continue to fall.

Positioning is less net-long than yesterday but more net-long from last week. The combination of current sentiment and recent changes gives us a further mixed USD/CAD trading bias.

Reserve Bank of Australia on the Precipice of Lower Rates?

The Reserve Bank of Australia’s June policy meeting came and went without much fanfare, failing to produce an interest rate cut despite markets pricing in the possibility (more on this below). In recent months, the RBA has already dropped its main overnight interest to an all-time low of 0.25%, implemented its own quantitative easing (QE) program, and issuing forward guidance to keep the three-year bond yield at 0.25% for the next three years.

RESERVE BANK OF AUSTRALIA INTEREST RATE EXPECTATIONS (JUNE 11, 2020) (TABLE 2)

Central Bank Watch: RBA, RBNZ, & BOC Interest Rate Expectations

According to Australia overnight index swaps, there is a 53% chance of a 25-bps rate cut at the July RBA meeting. But given the commentary from RBA Governor Lowe suggests that the central bank is not prepared to move rates into negative territory, making any further rate cuts unlikely; the pricing may be a quirk due to the shape of the Australian bond yield curve.

To this end, the RBA has said that it will target the three-year bond yield at 0.25% – the same rate as the overnight cash rate – which is a reasonable assumption that the RBA will keeping its overnight cash rate at 0.25% or lower for at least the next three years. Like the RBNZ, lower rates may be coming soon for the RBA – just not quite yet.

IG Client Sentiment Index: AUD/USD Rate Forecast (JUNE 11, 2020) (Chart 2)

Central Bank Watch: RBA, RBNZ, & BOC Interest Rate Expectations

AUD/USD: Retail trader data shows 33.38% of traders are net-long with the ratio of traders short to long at 2.00 to 1. The number of traders net-long is 2.44% higher than yesterday and 0.40% lower from last week, while the number of traders net-short is 14.23% lower than yesterday and 8.78% lower from last week.

We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests AUD/USD prices may continue to rise.

Yet traders are less net-short than yesterday and compared with last week. Recent changes in sentiment warn that the current AUD/USD price trend may soon reverse lower despite the fact traders remain net-short.

Reserve Bank of New Zealand May Not Be Done Just Yet

Nothing has changed for the Reserve Bank of New Zealand since convening their emergency meeting on March 16, where they slashed the main overnight cash rate by 75-bps to an all-time low of 0.25%. The coronavirus pandemic has not hit the New Zealand economy has hard as other developed economies – New Zealand hasn’t reported a new infection in a week – but that hasn’t stopped the RBNZ from going to its most extreme easing stance in its history in order to buffer the economy from contagion.

To this end, as part of the emergency interest rate cut, the RBNZ made clear that it would begin forward guidance, indicating that the main interest rate would stay at 0.25% for at least the next 12-months. But that doesn’t more can’t be done: the RBNZ noted that 0.25% “was currently the lower limit, given the operational readiness of the financial system for very low or negative interest rates.”

But at the May RBNZ meeting, the tone changed. “The committee noted that a negative official cash rate will become an option in the future, although at present financial institutions are not yet operationally ready,” the RBNZ said.“It was noted that discussions with financial institutions about preparing for a negative OCR are ongoing,” which “will become an option” in 2021.

RESERVE BANK OF NEW ZEALAND INTEREST RATE EXPECTATIONS (JUNE 11, 2020) (Table 3)

Central Bank Watch: RBA, RBNZ, & BOC Interest Rate Expectations

For now, markets are interpreting the commentary from the RBNZ that, while lower interest rates may be coming, they may not arrive in 2020. Through the last meeting of the year, the November RBNZ meeting, there is a 16% chance of a 25-bps rate cut – down from 28% one-month ago.

Our commentary remains static. “But against the backdrop where more dovish policy action has been hinted at by RBNZ Governor Orr, including extraordinary policy measures such as QE, then it would be shortsighted to dismiss the possibility of a rate cut arriving before the year is out.”

IG Client Sentiment Index: NZD/USD Rate Forecast (JUNE 11, 2020) (Chart 3)

Central Bank Watch: RBA, RBNZ, & BOC Interest Rate Expectations

NZD/USD: Retail trader data shows 29.10% of traders are net-long with the ratio of traders short to long at 2.44 to 1. The number of traders net-long is 31.76% lower than yesterday and 12.56% lower from last week, while the number of traders net-short is 6.53% higher than yesterday and 30.86% higher from last week.

We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests NZD/USD prices may continue to rise.

Traders are further net-short than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger NZD/USD-bullish contrarian trading bias.

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— Written by Christopher Vecchio, CFA, Senior Currency Strategist

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