The lack of U.S. economic reports on the calendar today means that it should be a subdued North American trading session in the foreign exchange market. The dollar is trading lower across the board with the losses led by USD/JPY. The currency pair turned lower after hitting a fresh 6-month high overnight. With long USD/JPY positions at its highest level since June 2007, profit taking is not unusual and in fact expected especially given the lack of U.S. data to drive the currency pair higher. We continue to view pullbacks in USD/JPY as an opportunity to buy at lower levels as long as the sell-off is contained to 101.50. If this support level is broken, it may be smarter to wait for an opportunity to buy below 100. Meanwhile the move lower in the dollar has driven the price of gold sharply higher intraday as the 25% decline this year is attracts bargain hunters.

The biggest event risk over the next 24 hours will be the Reserve Bank of New Zealand’s monetary policy decision at 3pm ET / 20 GMT on Wed. Of all the major central banks, the RBNZ is the most hawkish. In fact, they are the only ones talking about raising interest rates next year. The prospect of continued optimism has driven NZD to a 2 week high against the U.S. dollar and 5 year high versus the AUD. When we last heard from the RBNZ, not only did they say that rates will rise in 2014 but according to central bank Governor Wheeler, rates will increase 200bp or 2% by the end of 2015. Considering that some central banks are still thinking about increasing stimulus and others are only looking to unwind their asset purchases programs, the hawkishness of the RBNZ has and should continue to keep kiwis in demand.

The following table shows how the economy has performed since the last meeting in October. As you can see, outside of a decline in food prices and drop in building permits, there have been widespread improvements in New Zealand’s economy. Thanks to the improvement in the labor market, the people of New Zealand have grown more confident and this sentiment has boosted consumer spending, business and service sector activity. The only problem is outside their borders – there are signs of slower growth in China and Australia, New Zealand’s 2 largest trading partners.

With today’s announcement, the main question will be whether the recent appreciation in the currency has delayed the central bank’s plans to raise rates. As an export dependent economy, the level of the currency is extremely important for New Zealand. Currently, the RBNZ is expected to raise interest rates around March 2014 but if they place greater emphasize on concern about the currency over the brighter outlook for the economy, the NZD could weaken as investors interpret this as later tightening. It is hard to say where they stand because in late November Assistant RBNZ Governor McDermott said the exchange is overvalued and out of line with that is necessary for New Zealand to achieve its economic goals. He added that the central bank would like to see a lower exchange rate. In the last RBNZ statement however, the central bank noted that the currency remains high but simply said these gains provide flexibility on rate rises. While the value of the NZD/USD hasn’t changed significantly, the New Zealand dollar appreciated significantly against the AUD and this rise is more important for the country’s trade activity. Yet the RBNZ’s pain threshold for the currency could be higher now that China overtook Australia to become New Zealand’s number one trading partner in April and the NZD/CNY rate has not changed much since the last meeting.

If the RBNZ sounds more concerned about the high level of the currency, we expect the NZD to fall after the rate decision. If their views on the exchange rate remain unchanged, the NZD should extend higher. Based on the following chart of the NZD/USD our double Bollinger Bands show the currency pair attempting to renew its uptrend. If the RBNZ is unambiguously hawkish, NZD/USD could hit its November high of 0.8414 but if there are increased worries about the currency, NZD/USD could drop back to 0.8165, where the 200-day SMA and first standard deviation Bollinger Band converge.

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