Trade idea: NZD/JPY

At 07:00 AEST we saw the Reserve Bank of New Zealand (RBNZ) lower its cash rate by 25 basis points to 3.25%.

Source: Bloomberg

This move was called by only a third of economists surveyed by Bloomberg, while the swaps market had priced in a 46% chance of the cut. Clearly the NZD has been absolutely smashed this morning and it seems the market was clearly positioned for rates to be left at 3.5%.

If we look at moves in other markets we saw the two-year swap rate slide 12 basis points to 3.23% - the steepest decline since November 2012. This was clearly backed by a 56 basis point reduction in the RBNZ’s 90-day interest rate forecast to 3.11%, which was some 39 basis points (or 0.39%) below market pricing. Again, you can understand why the kiwi has been aggressively sold.

The bank has also suggested that ‘further easing may be appropriate’ and the market has certainly done a good job in pricing that in.

You have to respect the RBNZ though. They are very happy to be aggressive with the use of monetary policy and seem far more in tune with market pricing and expectations than many other central banks. Since 2014, you have seen the RBNZ move from the most hawkish central bank (at least in terms of its actions) to now being one of the most dovish or expansive. This should keep the NZD under pressure.

On the other side of the coin Bank of Japan governor Kuroda caused traders to cover JPY shorts as he suggested it was ‘hard to see the JPY (on a real effective exchange rate or REEF basis) falling further’. He also suggested the weakness in the domestic currency could now start depressing importers profits and real incomes. 

The JPY’s REEF (a trade weighted basket of currencies against the JPY) remains at levels it last saw in the mid 1970’s. If you look at classic longer-term valuation models such as purchasing power parity or the Big Mac index you can see the JPY is now significantly undervalued relative to the long run average. Recall the last time Kuroda made mention of the JPY (on a REEF basis) in December we saw the JPY strengthen 6%. Still, I am sceptical that the BoJ are keen on a stronger JPY and, to be fair, most of the weakness in the JPY of late has come from portfolio rebalancing from the massive Japanese pension funds and the subsequent capital outflows.

Still, as a vehicle to express a bearish NZD I think the JPY could be the right currency to trade here. Especially when NZ two-year swaps have the lowest premium to Japan’s since mid-2013.

Technically, the pair is breaking through key horizontal support, with the various oscillators highlighting momentum and trend is lower. Rallies therefore should be sold in my opinion and hence I choose to look at ¥86.85 – just below the 38.2% retracement of yesterday’s daily move and below the February/March double bottom. I am keen to target the February low. I’m targeting ¥84.20, with a stop loss at ¥88.95.

I am risk 210 points to make 475, although the techincals could change at any time and this would suggest adding or closing the trade.

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