KiwiBank predicts the Reserve Bank of New Zealand will reduce rates by 50 basis points in October and an additional 25 basis points in November, bringing the cash rate to 2.25% by the end of the year. This forecast is based on the economy’s inability to recover from a past recession, as reflected in weak GDP data.
There is a potential need for further reductions to 2% if economic conditions do not improve. KiwiBank calculates a 50/50 chance that additional monetary support may be necessary. The latest GDP figures show 10 out of 16 industries in contraction, indicating a lack of expected recovery a year after a severe recession.
Call For Strong Measures
KiwiBank urges the Reserve Bank to continue with strong measures to drive growth. This forecast indicates the growing urgency for the Reserve Bank to implement policy changes swiftly as economic growth slows. If the current weakness continues, there is a possibility of further easing towards a cash rate of 2%.
Given the new forecast for more aggressive rate cuts, we should position for a lower interest rate environment in the coming weeks. The focus will be on derivatives that profit from falling rates, such as receiving fixed in Overnight Index Swaps (OIS) that price in the October and November meetings. This view is reinforced by recent statistics showing the economy contracted by 0.2% in the second quarter of this year, adding credibility to the idea that the RBNZ must act decisively.
A sharply lower official cash rate will likely put significant downward pressure on the New Zealand dollar. We saw a similar dynamic during the 2008-2009 easing cycle, when aggressive rate cuts led to a steep decline in the NZD/USD exchange rate. Traders should consider using currency options, such as buying NZD puts, to position for a weaker kiwi dollar through the end of the year.
Market Volatility And Future Moves
The abrupt shift in expectations from a gradual easing path to a series of rapid cuts should also increase market volatility. After a period where inflation was a primary concern for the Reserve Bank, this pivot to prioritizing growth is a significant change. This makes long volatility strategies, like buying straddles on short-term interest rate futures, potentially attractive.
Looking further ahead, the entire New Zealand yield curve is likely to flatten and shift downwards as the market prices in the potential for the cash rate to hit 2.0%. This means we should look beyond the very front-end of the curve. It would be prudent to consider trades that capture this broader move, like receiving fixed on two-year interest rate swaps.
