The Reserve Bank of New Zealand (RBNZ) has released a statement showing that the NZD/USD Rate could be vulnerable to a further significant move towards the higher end in the wake of recent global economic data highlights. In its simplest terms, we are seeing a possible move towards an additional upside for the USD with a major retracement from current levels. In fact, RBNZ head of Research John Grant says that the Reserve Bank could have further interest rate cuts on hand in order to keep inflation low and stimulate the economy through higher wage growth in New Zealand. The comments come in the run up to the NZD/USD rate review scheduled for the week of July 14th.
This latest in a series of economic reports highlighting the risks associated with a continued global recession can perhaps explain why the NZD/USD is having such a difficult time breaking out of its recent downward trend. One of the reasons cited by analysts in New Zealand is that the current weakness of the New Zealand economy has been built upon a recent period of economic prosperity. Now, as this has all turned around, and the prospects for recovery become more dim, the risk of a sharp recovery is on the table. If the Reserve Bank were to hold off on any further cuts to the base rate, and instead pursue aggressive inflationary policy, then it is possible that the NZD/USD could be pushed up by as much as 50% against the USD over the course of the coming month.
In its most simple terms, inflationary pressures would lead the New Zealand economy into a period of sustained weakness, and would subsequently have a significant negative impact on the New Zealand economy. There are two potential outcomes here. One, inflation might push the NZD/USD higher, and without the Reserve Bank acting to remedy the situation, a massive trade deficit could result. Two, a sustained period of deflation could result, and this is where all the damage is likely to be done. A period of deflation means that the supply of goods and services in New Zealand falls, and the money supply falls to levels not seen in over three decades. If the economy cannot get back on its feet from this severe deflation, and the Reserve Bank does not introduce deficit financing, a significant retracement in the NZD/USD is highly likely to take place.
Historically, the best time for a currency to experience a retracement is when traders begin to sense that the base has strengthened and the base line is moving higher. Typically, the NZD/USD will begin to reverse its course as the market begins to realise that the current level is no longer an appropriate level. The second part of this scenario often sees a trading mass sell off as the USD pairs begin to make up ground. In these cases, it is usually the NZD/USD that suffers a large loss, with few if any traders profiting from this. This suggests that if you are a long term investor in New Zealand (or elsewhere in the region) you may want to hold off on buying until the third stage of the retracement occurs.
Traders need to realise that a third stage can occur. At this point, the NZD/USD could begin to reverse its trend, with the sellers closing out their positions. Obviously, this brings with it a number of benefits for the investors in New Zealand. Firstly, this implies that there is less pressure for the NZD to trade higher to counter the USD and opens up the trading channels for the secondary market. Secondly, it also provides a clear exit point from a position, which allows traders to take profits early on.
During the third stage, the NZD/USD may continue on its path but there is also a risk that a sharp reversal may occur. If this does happen, the major winners will have taken most of the action before the action reverses, meaning that the losers will only have had a small effect on the markets. The main benefit here is that traders may still be able to profit from this trading decision, provided that they are trading at the correct time. For instance, if an investor opts to buy at the start of the third stage, and wait for the end, they may still end up taking some profits as the value of the pair increases and continues on its course. However, they may not have been as lucky as the first part of the channel, where they had taken most of the action, and their investment could have been under a lot of pressure.
In order to minimise the risk of the third stage scenario, traders will want to take part in the trending or trading at the beginning of the third stage. They should also make sure that they are still comfortable with their entry points. It is during this stage when traders can use technical indicators to predict the direction of the currencies. Traders can also use breakouts to take advantage of the weakness in a particular pair. These indicators are most useful when paired with moving averages and MACD that can highlight a potential reversal.
The final stage of the NZD/USD relationship is known as the resistance stage. This stage is