US Dollar Drops But Why Did NZD Rally And Not CAD?

Central banks are taking bigger leaps to normalize monetary policy and investors are wondering If the Federal Reserve is next. On Wednesday, the Reserve Bank of New Zealand shocked investors by suddenly halting asset purchases. Although hawkishness was widely anticipated with a number of local banks forecasting a November rate hike, most expected the RBNZ to taper not cease asset purchases. But “more persistent consumer price inflation pressure,” that is “expected to build over time due to rising domestic capacity pressures and growing labor shortages,” prompted more aggressive action from the central bank. Unlike other countries, New Zealand’s labor market returned to pre-pandemic levels earlier this year and with the prices proving to be persistent, the Reserve Bank is worried that inflation could overshoot its target. Investors have fully priced in a November rate hike with NZD/USD rising above 70 cents. As one of the world’s most hawkish central banks, who placed themselves in front of the line for a rate hike, the RBNZ has set the change for further gains in the New Zealand dollar.

Photo by Jason Leung on Unsplash

The Bank of Canada also reduced monetary stimulus but their adjustment was less significant compared to the RBNZ. They scaled back bond buys for the second time in a row by 1 billion per week, which was more than the consensus forecast for an overall reduction of 1 billion. Yet unlike the New Zealand dollar, the Canadian dollar weakened rather than strengthened after the central bank announcement. Some would argue that the BoC’s announcement lost its luster after RBNZ but the central bank also laid out reasons why they think the increase in inflation is temporary, which suggests that a rate hike for Canada is still far away.

The U.S. dollar weakened against all of the major currencies as Treasury yields took a tumble. Federal Reserve Chairman Powell admitted that inflation data has been higher than expected and they lack certainty on transitory inflation even though they believe that to be the case. This line is important because it reinforces the possibility of Fed taper this year. Powell sees the next six months as critical for inflation, to see if falls back like they expect. The fact that he still maintains the view that inflationary pressures will subside indicates that policy changes are a ways off. The Fed is trailing behind New Zealand, Canada, and the U.K. central bank and the worry is they will fall further behind on the curve and be forced to tighten more aggressively in the future. Looking ahead, the Empire State and Philadelphia Fed surveys will provide a more insight into how quickly the Fed will act. If manufacturing activity continues to weaken, even if it is driven by supply chain disruptions, the Fed will wait. If manufacturing issues are resolved and activity accelerates, the pressure on the Fed to taper increases.

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