Lessons From the RBNZ

The New Zealand rate cut led to a brutal reversal in NZD/USD that later faded; we look at what the wild price swings mean. The Canadian dollar was the top performer Thursday while the yen lagged. Chinese retail sales and industrial production data is due later. US retail sales are due Friday. The 2nd NZD trade issued in the Premium Insights has been filled.

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The kiwi momentarily fell after the RBNZ rate cut then surged more than 150 pips because of a 50 bps cut or the lack of clear dovish commentary. However, as the day wore on, all the gains faded and NZD/USD finished the day virtually unchanged. Part of the subsequent decline was due because the RBNZ later said markets missed the downside risks in its monetary policy statement.

For many, the takeaway is confusion and (for once) that might be the right interpretation. Markets and central banks are reforming their relationship at the moment. For most of the past 30 years, trading central banks was binary in developed markets: rates went higher or lower. Central banking was a lever.

Markets have screamed throughout 2016 that the relationship is now much more complicated. The FX move – sometimes even the initial one – depends more on if the market believes the central bank made the right move and oftentimes why the cut is critical. Negative rate moves have backfired and markets are challenging central banks believed to be out of ammunition. Jawboning is ineffective and credibility at all central banks is strained.

Ultimately, interest rates remain an incredibly powerful tool but we may need to build in more space for volatility – especially at this time of year.

We also need to remain attuned to tail risks. Thursday was the anniversary of the yuan drop that roiled markets last year. China will inevitably be a source of instability again and there's an edge in watching more closely.  At the moment, economic data is solid but lending is a likely source of problems.

Today, the focus is on factories and consumers. At 0200 GMT, Chinese industrial production for July is due and expected up 6.2% y/y. At the same time, retail sales are forecast to rose 10.5% y/y.

Even a 1 percentage point miss won't roil markets on Friday but it could be a sign of trouble to come.