NZD/USD edges higher on positive market sentiment but systemic factors remain a drag

• NZD/USD edges higher continuing the gains from Wednesday when the Fed adopted an easing bias in its May policy meeting. 
• A positive tilt to market sentiment leverages gains for NZD/USD on Thursday. 
• Longer-term negative factors and the worsening economic picture in NZ are likely to continue to weigh. 

NZD/USD edges higher, up by eight-hundredths of a percent in the 0.5930s, on Thursday, as an improvement in global market sentiment helps commodity currencies, of which the Kiwi is a prime example. 

Risk appetite is seen rebounding on the back of falling Oil prices which have reached a seven week low in the mid $79s as well as an overall market-positive outcome of the US Federal Reserve’s (Fed) policy meeting on Wednesday. 

Lower Oil prices reduce costs for business and alleviate headline inflation, and the takeaway from the Fed’s May policy meeting was that although US inflation was not falling swiftly enough for the central bank to seriously consider cutting interest rates, neither was it entertaining the notion of raising them either. The Fed also decided to slow the reduction in its holdings of US Treasury bonds, effectively unwinding the pace of quantitative tightening – a dovish move that weakened the US Dollar (USD) in most pairs. 

Despite the recovery over the past 48-hrs NZD/USD is likely to remain under pressure over the longer-term, however, due to the poor performance of the New Zealand economy, which increases the chances the Reserve Bank of New Zealand (RBNZ) will cut interest rates before the US Federal Reserve. Since relatively lower interest rates reduce capital inflows, this is likely to hurt NZD more than USD. 

New Zealand’s run of poor macroeconomic data continues

Recent data from Statistics New Zealand, showed the New Zealand Unemployment Rate rising to 4.3% in Q1, its highest level for three years. New Zealand is in a technical recession after two quarters of negative growth. Furthermore, headline inflation fell to 4.0% (Core 3.7%)  in Q1 from 4.7% previously. Even though inflation remains well above the Reserve Bank of New Zealand’s (RBNZ) target of 1.0% - 3.0%, the pressure is increasing for it to lower interest rates to help boost the stuttering economy. 

More negative data out on Wednesday showed Building Permits fell 0.2% in March on a monthly basis –  worse still, on an annual basis, the number of homes consented to is down 25.0% suggesting residential investment will remain a drag on New Zealand growth, according to analysts at Brown Brothers Harriman (BBH). 

Business Confidence also fell to 14.9 in April, from 22.9 a month earlier, pointing to the third straight month of drop and marking the lowest reading since last September, according to data out on Tuesday. 

The RBNZ appears to remain split between doves who want to cut rates and hawks who want to raise them, according to Westpac Chief Economist Kelly Eckhold. Whilst weak growth and high unemployment would be aided by lower interest rates, inflation is not seen as falling fast enough in key areas to warrant lower interest rates.

“Stickiness in core inflation is consistent with embedded inflation expectations..with the implication that inflation may bottom out above 2% without further tightening. The balance of risks does not favor relying on a 5.5% OCR,” says the Chief Economist in her note “Hawks, Doves and Kiwis,” published on Wednesday. 

For NZD/USD the key question is which central bank – the Fed or the RBNZ – will move to cut interest rates first. Given the worsening economic situation in New Zealand and the Fed’s increasingly neutral position, the RBNZ seems more likely to be the first to make the move.