Forecast for the New Zealand Dollar: NZD/USD Positioned Between RBNZ Rate Hikes and Ukraine Tensions

The emotion-related Despite another volatile week for global stock markets, the New Zealand Dollar moved cautiously higher last week. The Dow Jones and Nasdaq Composite fell approximately 1.5% and 1.1%, respectively, on Wall Street. Europe and Asia likewise did not appear to be in a good position. The FTSE 100, DAX 40, and Nikkei 225 all declined by 1.9%, 2.5%, and 2.1%, respectively.

What may account for the disparity between the New Zealand dollar and market sentiment? Will this continue during the upcoming week? A possible cause is the decline in hawkish monetary policy expectations for the Federal Reserve. According to the CME FedWatch Tool, the probability of a 50-basis-point raise in March has decreased to approximately 21 percent from nearly 50 percent a week ago. This contributed to the weakening of the US dollar, strengthening the New Zealand dollar.

This was likely caused by geopolitical tensions and less aggressive Federal Reserve language. Next week, all eyes will be on a meeting between the United States and Russia. The former continues to feel that the latter is preparing an assault. Be wary if more Fed policymakers mention Ukraine. John Williams, president of the New York Fed, stated that he did not see a "compelling reason" for a significant hike in the prime rate.

On February 23rd, the Reserve Bank of New Zealand will make its first interest rate decision of the year. The central bank is anticipated to increase interest rates to 1.00 percent from 0.75 percent before. This year, overnight index swaps are pricing in nearly seven rate hikes, indicating a potentially aggressive tightening cycle. This implies that the central bank has a great deal of responsibility.

The inflation and labor market figures for the fourth quarter of New Zealand surprised to the upside, increasing the argument for an aggressive RBNZ. However, the downside risk for the New Zealand dollar could be greater if the central bank fails to live up to such bold hawkish wagers. This could result in a classic case of "buy the rumor, sell the news."

On the other hand, a close examination of the chart below reveals that a majors-based New Zealand Dollar index is struggling to track the rise in local 10-year government bond yields. This is an indication of the RBNZ's rising hawkish policy bets. So perhaps the New Zealand Dollar has some ground to make up. Nonetheless, it is difficult to disregard the detrimental influence of deteriorating market mood. In light of this, the forecast for the NZD in the coming week is neutral.