The Week Ahead: Week Of July 27, 2015

Source: FOREX.com

The Reserve Bank of New Zealand (RBNZ) is one of the most dovish major central banks in the world in contrast to the Fed, which is probably the most hawkish central bank in the developed world. This is obviously a major problem for NZDUSD that has been in a broad downward trend since mid-2014, which was a turning point for both the Fed and RBNZ. At the time, the Fed was becoming more and more hawkish as US economic data improved, while the RBNZ’s rate-tightening cycle had just ended and it was turning more dovish by the month while at the same time verbally assaulting an “unjustified and unsustainable” NZ dollar.

Since then the RBNZ has unwound some of last year’s policy tightening with two consecutive 25bps cuts to the official cash rate (OCR) in June and July, and the Fed has been setting the stage for a potential rate hike later this year. Yet, there’s a chance the market has underestimated the likelihood that the Fed will raise interest rates at its September meeting, and it may use this week’s meeting (a policy statement is due at 1800GMT on Wednesday) to prepare the market for such an event.

During a recent speech Feb Chair Yellen seemed to be a little more hawkish than the market; a view supported by a general improvement in the economic outlook for the US. The economy is adding jobs at a healthy rate and core inflation is gaining pace (CPI excluding food and energy rose 1.8% y/y in June). Overall, we think the time is right for the Fed to prepare the market for the increased possibility of tighter monetary policy as soon as September.

This is in complete contrast to the situation in NZ where the RBNZ is expected to lob another 25bps off the OCR in September. The bank has already cut interest rates at its last two meetings and noted at its policy meeting last week that further policy easing seemed likely. In fact, there is the distinct possibility that the RBNZ will lower the OCR to 2.5% this year from 3.00% currently, unwinding the entirety of the bank’s tightening cycle in 1H 2014 and pushing the cash rate back to a record low.

What does this mean for NZD/USD?

With the market returning its focus to yield differentials as the threat of a Grexit in the near-term dissipates, a currency pairing underpinned by a clear divergence of monetary policies is going to be tasty option for bears. If the FOMC meeting this week paves the way for a rate hike at the Fed’s next policy meeting in September, which is when we are expecting the RBNZ to loosen monetary policy, NZD/USD would be a relative safe option for US dollar bulls, especially given a recent collapse in dairy prices.

It’s worth noting that the kiwi rallied on the back of the RBNZ’s decision to cut interest rates last week, but this only appears to be a temporary relief rally from investors that were expecting the bank to be even more dovish, thus we don’t expect it to last. NZD/USD remains in a long-term downward trend and may finally break support around 0.6500, assuming the FOMC complies. On the upside, we’re eyeing the top of the pair’s long-term down channel, a break of which would negate our bearish technical view.

S&P 500

The S&P 500 peaked this past week around the 2125 level, just under May’s all-time high of 2134, before retreating significantly due partly to some major missed earnings releases in the US. Prior to this drop, the index had been climbing sharply in mid-July from its previous base around the 2035 level, which was a key support level that was last tested during dips in March and April. That climb was prompted by optimism over a potential resolution to the Greek debt crisis, a relative stabilization of China’s turbulent equity markets, and then a positive start to US earnings season. The resulting rebound pushed the index swiftly back above both its 200-day and 50-day moving averages once again. The subsequent retreat, however, has prompted a return back down to the 50-day average. Despite recent positive economic reports out of the US, including brisk home sales and low unemployment claims, the S&P 500 continues to be under the sway of major company earnings for the time being. Within this context, there is substantial risk of a further pullback, especially if the index finds its way below the 200-day moving average and the key 2070 level. In this event, major downside support remains around July’s lows at the noted 2035 level. While this pullback could well occur, the S&P 500 continues to trade within a long-term bullish trend going back more than six years, and could continue this longstanding uptrend after the current pullback. The clear upside target in this event is at the noted 2134 record high. From a longer-term technical perspective, any further move above that high, in uncharted territory, could begin to target further upside around the 2200 level, which is around the 161.8% Fibonacci extension of the most recent major pullback from the all-time high down to the 2035-area base.