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All eyes are on the Reserve Bank of New Zealand on Wednesday as investors await a key interest rate decision, due to be released at 02:00. A little more than 24-hours ago, traders were nearly 100% convinced that policymakers would hike the Official Cash Rate by 25 basis points, but a dramatic turn of events in the country now have traders guessing about the decision.
On Tuesday, the NZD/USD settled at .6918, down 0.0101 or -1.44% and the AUD/USD finished at .7254, down 0.0081 or -1.11%.
Tuesday’s Recap
The Aussie and Kiwi took a major hit on Tuesday as undesirable coronavirus news threatened to upend the assumed hawkish outlook for monetary policy in both countries. The fresh developments drove domestic bond yields sharply lower, making both currencies undesirable for global investors.
According to Reuters analysts, the most dramatic development came in New Zealand where authorities reported a new community case of COVID-19, the first since February and a sudden risk to what has been one of the world’s strongest economic recoveries.
The Australian Dollar also tumbled, hitting a one-month low after the minutes from the Reserve Bank of Australia’s (RBA) August 3 meeting showed the policy board is willing to provide more stimulus if necessary to offset the anticipated damage from the current surge in COVID-19 cases.
Australia has been struggling with a coronavirus outbreak for weeks, leading to lockdowns in Sydney, Melbourne and Canberra.
The comments from the minutes dragged 10-year bond yields down to 1.16%, just a whisker above seven-month lows and 10-basis points below comparable U.S. yields.
Short-Term Outlook
Yesterday, the RBNZ had been expected to raise interest rates to cool the economy, and to signal a string of further increases.
Shortly before the RBNZ decision, investors were having second thoughts given the risk of a sudden lockdown in Auckland and the country’s relatively low vaccination rates.
Reuters is reporting that markets for interest rate swaps moved quickly to scale back their implied tightening to less than 21 basis points, from fore than 30 basis points early in the day.
The probability of a quarter-point hike fell to 82%, from more than 100%, while the market completely erased any chance of a half-point increase, Reuters reported.
One-year swap rates also fell as investors reconsidered how fast and far the RBNZ would tighten. Cash rates have been at a record low of 0.25% since last March when the central bank eased aggressively as the pandemic first hit, Reuters wrote.
Look for the NZD/USD to rally if the RBNZ follows through and hikes its OCR by 25 basis points. Gains could be capped, however, due to the uncertainty over the timing of future rate hikes.