What Are The Markets Facing?

Expansion in New Zealand is anticipated to contract for the first time in just over two years during the first quarter, as GDP is expected to fall 0.3 percent and drag the annualized figure down to 2.1 percent from 3.7 percent. The culprit? Record high interest rates. The Reserve Bank of New Zealand has left rates at a restrictive 8.25 percent since last summer in an attempt to fight rocketing inflation pressures in the economy. Indeed, a decline in GDP is essentially the intended result of these monetary policy actions, as weaker expansion will weigh on inflation pressures, and the news will likely lead the markets to continue speculating that the RBNZ will cut rates in the third quarter. As a result, there is massive downside risk for New Zealand’s assets on Thursday.

Bonds – 10-Year New Zealand Government Bond Yields

New Zealand’s government bond yields could be in for a drop toward trendline support near 6.390 this week, as NZ GDP is expected to have contracted during the first quarter. If this is indeed the case, the RBNZ will have far more scope to consider cutting interest rates this year, which would send yields tumbling. On the other hand, a surprisingly strong GDP reading will spark speculation that looming inflation risks will force the central bank to keep monetary policy restrictive, which could lead yields to jump.

FX – NZD/USD

The New Zealand dollar continues to trend lower, though the currency has recently bounced from the confluence of trendline and Fibonacci support near 0.7430/50. Thus far, the NZD/USD recovery has had trouble breaking above 0.7650, and the upcoming release of NZ GDP could send the pair plummeting. Indeed, GDP is expected to have contracted during Q1 as the economy feels the impact of record high interest rates. As a result, NZD/USD could fall below immediate support at 0.7550, with sharp declines likely to target 0.7450 once again. On the other hand, if the data is surprisingly strong, the pair could break above near-term resistance to target a falling trendline near 0.7700.

Equities – NZX 50 FF Gross Index

The stock markets in New Zealand have taken a beating over the past eight months or so, as the three of the four largest companies in the index (which had a combined weighting of 45.3 percent at the beginning of the year) have all experienced heavy losses. Indeed, the NZX 50 is likely to head even lower in the near-term if NZ GDP contracts in line with expectations. The next major level of support looms at the December 2005 low of 3,182.96, though 3,200 could hold up as a psychologically important level.

Terri Belkas is a Currency Strategist at FXCM.