NZD/USD: Trade Wars, Not Rate Cuts, Are Calling the Shots

• RBNZ sees neutral rates between 2.5-3.5%, hinting at more cuts ahead
• NZD/USD traders shrug off rate differentials, fixated on US trade policy
• Market pricing suggests at least four more RBNZ cuts by year-end
• Technical levels hold firm as NZD/USD rides tariff-driven volatility

Summary

The Reserve Bank of New Zealand (RBNZ) says monetary policy remains in restrictive territory despite slashing interest rates by 125bps this cycle, implying there will be a need to continue reducing the overnight cash rate if inflation continues to subside. Its estimate for the range where interest rates keep unemployment and inflation stable are slightly lower than where markets expect the cash rate to bottom this cycle, suggesting the aggressive cuts seen over the past two meetings may extend well into 2025 should there be no evidence of a pickup in the economy.

While large scale rate cuts create downside risks for NZD/USD on a pure interest rate differential basis, right now, that’s a distant secondary consideration for traders. If you want clues on NZD/USD directional risks, evidence suggests you need to pay close attention to trade policy from the United States under the Trump Administration.

A primer on long-term nominal neutral interest rates

It’s a mouthful, but the concept is simple. It’s the level where interest rates keep inflation and unemployment are stable. Think of it as cruise control for an economy, where growth isn’t too fast or too slow.

It’s called “nominal” because it doesn’t account for inflation, and “neutral” because it’s not trying to restrain or stimulate activity. Central banks use it to guide expectations on interest rates. If rates are below the estimated level they’re trying to speed things up, and vice versus when above.

The emphasis needs to be on estimated as neutral is a dynamic level which constantly changes, influenced by things like population growth, productivity, and people’s willingness to save or spend.

RBNZ estimates neutral is below 4.25%

Paul Conway, Chief Economist at the RBNZ, estimates New Zealand’s neutral interest rate currently lies between 2.5% and 3.5%, below the 4.25% level where the overnight cash rate currently resides.

Source: RBNZ

“Easing domestic pricing intentions and the recent drop in inflation expectations help open the way for some further easing, as signalled in the November 2024 Monetary Policy Statement,” Conway said during a webinar hosted on Wednesday.

“Given uncertainty, we will need to ‘feel our way’ as the OCR gets closer to our estimate of neutral.

“We will continually cross-check our estimate of the neutral interest rate by comparing the proximity of the OCR to neutral against what we are seeing in the real economy.”

Markets see neutral around 3%

Source: Bloomberg

Overnight interest rate swaps indicate where markets expect the cash rate to settle in the future. By the next RBNZ meeting on February 19, markets anticipate it will drop to 3.762%, implying a nearly fully priced 50bp cut. By year-end, four 25bp cuts are expected, with a strong chance of a fifth, leaving the cash rate at 3%. This aligns with the midpoint of Conway’s range and the bank’s November guidance.

RBNZ rates a minor consideration for NZD/USD

Although the RBNZ is expected to cut rates faster than the Federal Reserve in 2025, this outlook is already factored in and has had minimal influence on NZD/USD moves recently.

Instead, the pair has shown a stronger inverse relationship with US equity market volatility futures, implied US bond market volatility, and the offshore-traded Chinese yuan (USD/CNH). This highlights the role of US trade policy speculation, which has caused sharp swings in NZD/USD.

Source: TradingView

Despite resembling a washing machine on spin cycle on an intraday basis, NZD/USD continues to respect technical levels. After breaking above downtrend resistance early last week, the pair found support at .5650 on three occasions in the past five sessions.

Momentum indicators like MACD and RSI (14) remain bullish, favouring a cautious near-term upside bias, with dips and topside breaks preferred over selling rallies.

Key resistance levels to watch include Friday’s high near .5725, the 50-day moving average, and horizontal resistance at .5754.

A sustained break below .5650 would invalidate the bullish bias, opening the door for bearish setups targeting a potential retest of early January swing lows.

-- Written by David Scutt

Follow David on Twitter @scutty

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