Quick Take: RBNZ Dovish Surprise! Market Overpricing 2024 Cuts

Summary

• The RBNZ cut the OCR 25bps to 5.25%, against our expectation for no change.
• Material weakness in high-frequency data and updated research from the central bank drove the dovish update. There were large changes to GDP and tradables inflation forecasts.
• Ahead, the RBNZ are forecasting 25bp cuts at the next three meetings before slowing. A 3% terminal rate is expected.

Market Implications

• Markets are overpricing RBNZ cuts. We expect a further two cuts this year versus the 3.2 priced.

Dovish RBNZ Cut

The Reserve Bank of New Zealand (RBNZ) cut the OCR 25bps, against our expectation for rates to be left unchanged. Governor Orr revealed that a 50bp cut was considered. An increased weight on high-frequency indicators and new research drove the dovish shift. Updated forecasts imply 25bp cuts at the next three meetings. We think the market has gotten ahead of itself, pricing three cuts into year-end.

Placing Greater Weight on Softer Data

The decision to ease came on the back of a ‘material weakening’ across a broad range of high-frequency indicators (Charts 1 and 2). The RBNZ assessed that the output gap is now more negative than assumed in the May MPS

A Dose of Dovish Research

RBNZ’s updated research helped the dovish case. Initially, in 2015, the RBNZ changed the way price setting behaviour is incorporated into their structural inflation models (NZSIM) to a modelled measure, from a survey measure. The decision reflected a range of analysis – Karagedikli and McDermott (2016) and McDonald (2017). Now, in 2024, they rerun the analysis. They found that modelled measures that adapt quickly to changes in inflation outperform highly persistent measures in NZSIM.

So, their research favours ripping out components that disinflated slowly in the medium-term for those that progressed quickly. As a result, RBNZ forecasts now ‘adjusts to a low-inflation environment more quickly’ (Chart 3).

What Comes Next? Market Overpricing 2024 Cuts

The updated OCR forecast implies 25bp cuts at the next three meetings before slowing the pace (Chart 4). The terminal rate is forecasted at 3.0%.

The market is pricing at least 75bps of cuts into year-end, versus the RBNZ’s forecasted 50bps. Punchy. It would require data to come out relatively dovish. That’s relatively dovish to a forecasted Q2 (-0.5% QoQ) and Q3 (-0.2% QoQ) technical recession, the second largest unemployment unwind of the 21^st century, and the 1.1pp downgrade to the tradeables inflation forecast (August MPS: -0.2% QoQ vs May MPS: +0.9% QoQ).

Market Implications

We think markets are overpricing RBNZ cuts into year-end. We expect 25bp cuts in October and November, versus the 3.2 cuts priced by the market. In FX, NZD following the release. There are a couple signs we are peak bearishness for the Kiwi dollar – pricing for cuts is extreme, the basic balance appears to be troughing, and asset managers are near records in positioning. Our bias remains that we want to find room to fade AUD/NZD highs.

Ben Ford is a Researcher at Macro Hive. Benjamin studied BSc Financial Mathematics at Cardiff University and MSc Finance at Cass Business School, his dissertations were on the tails of GARCH volatility models, and foreign exchange investment strategies during crises, respectively.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)