FxWirePro: Kiwis monetary policy preview - Deploy debit put spreads to hedge NZD/JPY ahead of RBNZ

NZ RBNZ Official Cash Rate review: (scheduled on June 26th, Previous: 1.50%, Consensus: 1.50%)

In May, the RBNZ cut the OCR and mentioned that the outlook was finely balanced between having to cut once more at some stage or leaving the OCR on hold at 1.5% for an extended period. The RBNZ has stated that it is now in “data-watching mode”, meaning it could jump either way depending on what happens. 

RBNZ is now expected to leave the OCR on hold in this upcoming June meeting review. The balance of risks has evolved in the direction of another cut (mainly due to global developments), but not so emphatically that the RBNZ needs to cut the OCR again so soon. 

As discussed in this week’s essay, we now think the odds favor the RBNZ cut the OCR to a new low of 1.25% in August. Hence, we reckon that the prevailing rallies of NZDJPY are momentary, NZD is expected to depreciate towards 67 levels by year-end. 

In contrast to Australia, where the export-relevant commodity markets are already tight, New Zealand’s agricultural exports are subject to both a negative demand shock (China) and a loss of market share (negative domestic supply shock with rising global supply). Dairy prices have weakened, dragging the trade balance to the widest deficit in a decade. While the fall in oil prices will likely offer some reprieve, exports remain constrained and are unlikely to benefit from a redistribution of China’s GDP growth toward fixed asset investment. 

Most importantly, 3m IV skews are right indications for NZD that have clearly been indicating bearish risks. Hence, the major downtrend continuation shouldn’t be panicked the broad-based bearish outlook amid minor rallies. 

These positively skewed IVs of 3m tenors signify the hedgers’ interests to bid OTM put strikes up to 69 levels (refer above nutshells evidencing IV skews).

The global risks are reckoned to play less conducive for NZ than they do for Australia, and the central bank has reason to be credibly dovish even as the data have outperformed some of the downside risk scenarios laid out earlier in 2018. The pair is forecasted to depreciate to 67 by year-end.

While the NZDJPY trade is underwater following positive news reports on a US-China agreement. The erratic nature of news flow is one reason why we had suggested NZDJPY shorts via options in the past, suitable options strategy is designed favoring a bearish side. Initiate longs in -0.49 delta put options of 3m tenors, simultaneously, short (1%) out of the money put options of the narrowed expiry (preferably 2w tenors), the strategy is executed at net debit.

Well, a higher (absolute) Delta value is desirable on the long leg in the above-stated strategy. Whereas, the Theta is positive on the short leg; as the time decay is good for an option writer (that’s why we’ve chosen narrowed expiry). The short side likely to reduce the cost of hedging with time decay advantage on the short leg, while delta longs likely to arrest potential bearish risks. Courtesy: Westpac & Sentrix

Currency Strength Index: FxWirePro's hourly NZD spot index is inching towards 136 levels (which is highly bullish), JPY is at 20 (mildly bullish) while articulating (at 08:40 GMT). 

For more details on the index, please refer below weblink: http://www.fxwirepro.com/currencyindex