The RBNZ surprised markets by cutting the official cash rate by a greater than expected 50bps, front-running further expected easing from the FOMC, and RBA. Governor Adrian Orr commented that negative rates are “within the realms of possibility”. Despite this clear dovish signal – and the negative outlook for the economy (top-left chart) – markets have not taken seriously the prospect of zero rates, let alone negative rates in New Zealand. The OIS market currently expects the policy rate to bottom at 0.61%, only about 40bps of further cuts.

However, there is good reason to expect the RBNZ to turn more dovish than expected, which in turn provides scope to go short NZD and long NZ rates. Moreover, real rate differentials favour a weaker NZD (top-right chart). New Zealand has built up considerable exposure to Chinese demand with 27% of total exports destined for China. The export basket is also heavily skewed towards food commodities (namely milk and meat products), which has left New Zealand vulnerable to a global trade shock – the probability of which continues to rise. Finally, Australia is a close competitor in agricultural goods and has already gained a considerable competitive advantage through the devaluation of its real effective exchange rate.

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Source: Bloomberg, Macrobond, Variant Perception