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KDnuggets.
The financial market is the ultimate testbed for predictive theories. With this post we want to highlight the common mistakes, observed in the world of predictive analytics, when computer scientists venture into the field of financial trading and quantitative finance.
By Lars Hamberg .
Many common mistakes can be avoided when testing sentiment data for predictive properties. Here is one:
The term “prediction” is not a legal definition. In assessing the predictive qualities of sentiment data there are no rules for what counts as a signal to be tested for predictive properties with regard to financial assets.
However, the method you chose ultimately defines what you mean with the term “prediction”.
To illustrate the point: Using a more prudent definition of the term, the accuracy in the world’s most famous prediction study could have been as low as 47% (7 out of 15) instead of 87% (13 out of 15%) .
An accuracy rate of 47% would not have produced worldwide media attention and more than 1600 academic citations, in my view.
The financial market is the ultimate testbed for predictive theories. A successful prediction tool for the financial market is a tickling idea and mind-boggling, in terms of implications.
A few years ago, a study* called ”Twitter mood predicts the stock market” (“the Bollen Study”), by Johan Bollen, Huina Mao and Xiaojun Zeng (“Bollen”) received a lot of media coverage.
With more than 1600 academic citations, it remains the most cited paper in the field of investigating the use of sentiment data in prediction models for financial risk assets.
With this post I want to highlight a common mistake, observed in the Bollen study, and elsewhere in the world of predictive analytics, when computer scientists venture into the field of financial trading and quantitative finance:
Assume that your sentiment data produces a new signal every day. For some reason, your sentiment signal suggests that the market will move up the following trading day. This repeats itself, every day for 20 consecutive days, and the market keeps going up, every following trading day.
Your textbook on financial markets says that daily market directions are random. As a consequence, you believe that your model has 20/20 prediction accuracy for something that is known to be random!
This calls for champagne, since your model correctly called the coin-flip 20 times in a row! Or, did it really?
Have you stumbled across the greatest discovery of all times? No, of course you haven’t.
Does your sentiment signal have some kind of predictive properties? Probably not… Sorry!
Cancel the champagne and start consulting your critical faculties:
In academic papers regarding market predictions based on social media there are often references to the fact that the Efficient Market is since long disputed and that price formation may not be random.
Typically, people behind these papers hypothesize that price formation and market direction may be predicted through analysis of social media, or similar. That’s the basic idea subject to investigation.
As a consequence, it runs contrary to reason to test whether market direction is systematic under the testing condition that market direction is random, wouldn’t you agree?
Still, this is exactly what some people tend to do, which may surprise many practitioners within quantitative finance. The Bollen study has been academically cited more than 1600 times and remains the world’s most cited study in this field of research.
The results in the Bollen Study refers to a cumulative binomial probability (0.35%) as a mark of robustness in a prediction accuracy (86.7%) based on 15 observations, as if the model had correctly called 13 out of 15 coin flips.
Beyond the obvious problem with very small samples, Bollen is testing whether market direction is systematic under the testing condition that market direction is random. This general approach is problematic for a number of reasons:
Since causality is, typically, unclear, and since the possibility of both feedback loops and clustering effect must be considered with regard to both time series, any proper testing for predictive properties must be carried out using methods that take into account that both time series may be random or systematic; random in some time intervals and systematic in others; independent and dependent; independent in some time intervals and dependent in others; leading or lagging, as well as both leading and lagging, in different time intervals.
One such method, with regard to market direction, is to only count changes in direction forecast – i. e. to only count when sentiment data changes from LONG to SHORT, or vice versa – as proper sentiment signals to be assessed against the actual aggregate market direction for the entire time period between changes in sentiment signals . This, for instance, is the method used in the ongoing multi-year prospective prediction study (“WIM”), available online at whatismonitor.
Hence, in order to use the method described, the sentiment data must produce a signal expressed as LONG or SHORT or BUY or SELL, or similar, and the accuracy of prediction must be based only on those instances when the sentiment signal changes, i. e. from LONG to SHORT, or vice versa.
To illustrate the point: if your sentiment data changes from SHORT to LONG on day 1 and keeps telling you to be LONG for the following 5 days in a row, after which it changes back to SHORT, and the market moves up during the first 4 of those 5 days, it does not mean that your model has been 80 per cent correct. Nor does it mean that your model has been right even one single time, i. e. regarding the four-day upward move.
In order to count the predictive signal as a “success” or a “failure” in the study it’s reasonable to look at the aggregate price move over the entire five-day period, i. e. up to the point when the predictive signal has “closed the trade”, by means of a change in signal: from LONG to SHORT, or vice versa.
If, and only if, the market – or the price – moved up over the entire five-days, i. e. the time period between the changes in signal, from SELL to BUY and back from BUY to SELL, can it be counted it as one successful prediction.
Reversely, if the price had moved down, the observation would have been logged as one failed prediction. Regardless, – with this definition of “statistically predictive signals”, “predictions”, it remains one single point of observation.
It appears that Bollen used a different method. The impressive headline number of 87% (86,7%) accuracy, in predicting daily moves on the DJIA, was achieved during 15 trading days. During these 15 days Bollen implies a hit-ratio of 13 days out of 15 days.
However, is worth noting that the market didn’t change direction more than 8 times during the 15-day period, i. e. the first 15 trading days in December 2008. [table]. On two occasions, during these 15 trading days, the market direction remained the same for two days in a row, and on one occasion, the market direction remained the same for three days in a row.
What does it tell us?
In short order, it tells us that – with the prudent definition of the term “prediction” – the 87% (13/15) accuracy in the Bollen study could never have been achieved.
With a prudent definition of “prediction”, the accuracy in Bollen’s signals could actually have been as low as 47% (7/15) and still produce an accuracy of 87% (13/15 ) with Bollen’s definition of “prediction”.
An accuracy rate of 47% would not have produced worldwide media attention and more than 1600 academic citations, in my view.

Forecasts.
US Dollar Looks Vulnerable Through the End of 2017.
Fundamental analysis, economic and market themes.
Fundamental Forecast for the US Dollar : Neutral.
US Dollar drops after FOMC despite seemingly hawkish outcome PCE inflation data, GDP update unlikely to discourage USD bears Successful tax cut vote may help, but it might be priced in already.
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Last week’s FOMC monetary policy announcement was billed as decisive for the US Dollar, and on this score, it did not disappoint. Indeed, the outing marked the currency’s most volatile day in over two months. It plunged against all of its major counterparts, tellingly tracking a drop in Treasury bond yields and a flattening of the 2018 tightening path implied in Fed Funds futures.
This textbook response to a “dovish” policy outturn is difficult to reconcile with Fed guidance seemingly steering in the opposite direction. The committee projected three rate hikes next year, topping priced-in bets. It lifted forecasts for growth and employment too. Fed Chair Yellen even stressed that officials’ rosier outlook didn’t reflect anything new on fiscal policy, signaling confidence in underlying economic strength.
A raft of explanations quickly surfaced. Some cited profit-taking, claiming the outcome was already priced in. Others pointed to the disconnect between an unchanged rate hike forecast and the GDP outlook upgrade, saying it meant the Fed is reluctant to tighten even as growth accelerates. Perhaps the most compelling theory blamed year-end flows, with passing event risk allowing traders to juice the last of the year’s top trends.
In any case, the markets weighed up the last of the year’s critical fundamental news-flow and clearly signaled their disposition, hinting that the greenback may face still more selling before the calendar turns to 2018. A revised set of third-quarter GDP statistics and November’s PCE inflation data would probably need to come in a lot better than expected to tip the scales in buyers’ favor in the week ahead.
The fiscal side of the equation remains a wildcard. Last-minute wheeling and dealing among Congressional Republicans appeared to secure enough support to pass long-promised tax cut legislation, with a vote possible as soon as Monday. The markets’ post-FOMC response suggests this has already entered into asset prices, but the Dollar may find a bit of residual support once the “ayes” are counted.
This note was originally published on December 15, 2017.
--- Written by Ilya Spivak, Senior Currency Strategist.
Sideways Trading Through End of 2017 Looks Likely for Euro.
News events, market reactions, and macro trends.
Fundamental Forecast for EUR/USD: Neutral.
- Futures positioning remains a major impediment for the Euro, with net-long positioning at a fresh 2017 high and its highest level since May 2007.
- The ECB won’t be raising rates in 2018 but will continue with its normalization process, likely leaving the Euro without the central bank as a significant driver in the near-term.
- The IG Client Sentiment Index suggests improved conditions for EUR/USD in the coming days.
The Euro finished near the bottom of the major currencies covered by DailyFX Research last week, dropping the most against the antipodean sisters (EUR/NZD -2.34%; EUR/AUD -2.03%), with no other losses in excess of -1%. EUR/USD was barely lower by -0.20% (but finished Friday particularly poorly) and EUR/GBP was a touch higher, by +0.32%.
At its December policy meeting, the European Central Bank offered a similar assessment of its rate expectations and forward guidance as it did at the October iteration. Concurrently, it’s near-term GDP and inflation forecasts (2018 and 2019) were upgraded, but the 2020 inflation forecast was not, highlighting the ‘cautious optimism’ policy officials are viewing the recovery.
While this means traders may be disappointed that no rate hikes are coming next year, it does mean that normalization is well under way, which should keep the Euro supported for the foreseeable future. Unfortunately, this leaves the Euro without the European Central Bank as a significant driver heading into 2018. The ripple effects are small, but important: if ECB policy is deemed to be on a set course for the next several months, it may mean price action around typically important releases like the CPI or PMI reports is dampened going forward.
In the week ahead, the Euro sees a quieter economic calendar than last week, no surprise in the run-up to the Christmas holiday. The final Euro-Zone CPI report for November shouldn’t leave much in its wake on Monday. Otherwise, the German IFO report should have minimal impact on price action on Tuesday, as will the final Q3’17 French GDP report on Friday. Likewise, during the week between Christmas and New Year’s, we shouldn’t look to the calendar as a significant source of event risk.
Heading into the final two weeks of 2017, the Euro has firm fundamentals supporting it. Economic data momentum is solid and remains near multi-year highs, with the Euro-Zone Citi Economic Surprise Index finishing Friday at +70.3, up from +60.1 the week prior and still higher than +58.9 a month ago. The final PMI readings for November released thus far have showed that growth momentum in the Euro-area is at its strongest pace since 2011.
Taking a look at market-derived indicators of price pressures, t he 5-year, 5-year inflation swap forwards, one of ECB President Draghi’s preferred g auges of inflation, closed last week at 1.705 %, a touch lower than the 1.708% reading a week earlier, but still higher than the 1.670 % reading a month ago. Given that Euro strength has sustained itself over the past few months, evidence that inflation expectations continue to trend higher should put to rest any near-term concerns that the ECB might have over tapering the pace of its asset purchases as the calendar turns into 2018.
We still believe that the biggest obstacle to further Euro strength lies not with the ECB or upcoming economic data, or even politics heading into the final two weeks of the year; but rather where market positioning stands. T he Euro long trade in the futures market remains crowded among speculators/non-commercial traders .
According to the CFTC’s la test COT report, there were 113.9 K net-long contracts held by speculators for the week ended December 12, the highest level since the week ended May 15, 2007. After positioning peaked in May 2007, EUR/USD dropped over the next four weeks for a loss of just over -3%.
While this isn’t enough information alone to act on a contrarian short Euro position, it is enough of a reason to curb our enthusiasm about the Euro’s otherwise improved fundamentals, suggesting that choppy, sideways range trading is due through the end of 2017 – and if weakness does transpire, it’s merely a saturated market taking profits on Euro longs.
This was originally written on December 17, 2017.
--- Written by Christopher Vecchio, CFA, Senior Currency Strategist.
To contact Christopher, him at cvecchiodailyfx.
BoJ Discusses Reversal Rate as The Quest Continues Towards the Elusive 2%
Price action and Macro.
Fundamental Forecast for JPY: Bearish.
Next week brings the final Bank of Japan rate decision for 2017. It’s been a rather quiet year for the BoJ, all factors considered; and quite the respite from the past few years when their very own policies were very much in the spotlight. Last year saw the stealth move to negative rates in January , catching many by surprise and leading to a troubling five-month period that saw USD/JPY drop all the way from above 121.50 to below 100.00. The oncoming ‘reflation trade’ that started around the U. S. Presidential Election in November pushed prices back towards that 120.00 level, falling just short as a double-top was set at 118.67 in December/January. After a pullback in the first quarter of the year, USD/JPY sank into a range that’s lasted ever since, now going on for seven full months.
USD/JPY Has Spent the Bulk of 2017 in a Range-Bound Fashion.
The big item of pertinence circling around the Bank of Japan, and likely to be on full display next week is the bank’s outlook towards stimulus. The stimulus program that came into markets around the election of Prime Minister Shinzo Abe has continued to drive into Japanese markets going on five years now. And while inflation initially showed a promising response, eclipsing the BoJ’s 2% target temporarily in 2014; those hopes have fizzled in the years since as the Japanese economy has moved back towards the deflationary cycle that defined the economy for much of the past thirty years.
For the past year, inflation has remained between .2 and .7% in Japan , and this is with an outsized stimulus program in effect. After four consecutive months at .4% this summer, a quick visit to .7% in August and September led into a drop back-down to .2% in October. So, it would appear that we remain very, very far away from attaining the BoJ’s goal, with little hope in the immediate sights.
In September, we started to hear machinations around a potential increase in stimulus . This is when incoming BoJ member, Gouishi Kataoka, dissented at the BoJ’s rate decision. Dissent within the BoJ isn’t necessarily new, as we regularly heard prior board members Takahide Kuichi and Takehiro Sato dissent at meetings in the past. But their dissent was largely looking for an end to stimulus, or at least less of it; and the thought was that we’d seen more unanimity when their terms ended in July of this year. But, with Mr. Kataoka coming into the BoJ in July, the dissent continued, and this time in the opposite direction as the proposition was to see even more stimulus in the effort of driving the Japanese economy towards the 2% inflation target.
This theme saw a twist last month. BoJ Governor Haruhiko Kuroda mentioned the ‘reversal rate’ in a speech, and questions began to populate as to whether the head of the BoJ was dropping hints towards an eventual stimulus exit. Reversal rate is the rate at which rate cuts become detrimental for an economy, and given how loose policy has been for so long in Japan, this could be denoting a higher bar for future stimulus endeavors. This was initially interpreted as Gov. Kuroda noting that additional rate cuts may actually do damage to the Japanese economy, and this put market participants on high alert for a potential announcement moving the bank away from their gargantuan stimulus program in the coming months. But – in a clarification after the fact, we learned that ‘reversal rate’ entered the conversation at the prompting of Mr. Kataoka, in order to flag risks around additional easing; and now it seems as though this inclusion of the term ‘reversal rate’ is actually in order to lay the groundwork for even more stimulus in the future.
The BoJ appears committed here, and given the Japanese economy’s continued struggle to attain the elusive 2% inflation target, it would appear as though we’re nowhere near the conversation of stimulus exit.
The forecast for the Japanese Yen will be set to bearish for the week ahead.
--- Written by James Stanley , Strategist for DailyFX.
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Contact and follow James on Twitter: JStanleyFX.
GBP Set to Rally as Preliminary Brexit Shackle is Removed.
Fundamental analysis and financial markets.
Brexit shackle removed but trade talks will be long and complex. Next week’s economic calendar is full of potential market moving events. Double head and shoulders broken, EUR/GBP heading south.
Fundamental Forecast for GBP: Bullish.
We have turned bullish on GBP, especially against EUR after Friday’s announcement that the EU will recommend that the second phase of Brexit talks can start. Removing this fundamental block should allow GBP to drift higher against the EUR in the medium-term, especially as the ECB has no intentions of moving rates higher in 2018 with inflation at its current lowly rate.
We would take care with any EUR/GBP short position next week however as the economic calendar is packed with central bank meetings and market moving data. UK monetary policy will remain unchanged when the Bank of England meet on Thursday December 14 but commentary from Governor Mark Carney may suggest that inflation in the UK is still far too high, prompting thoughts of another 0.25% rate hike in H1 2018. We will get a look at the latest UK inflation data on Tuesday December 12 at 09:30am and updated wages and employment numbers are released at the same time on Wednesday December 13.
A look at the chart below shows EUR/GBP has completed a pair of head and shoulder formations since late September and with the neckline broken, the downside beckons for the pair. Fibonacci retracement at 0.86920 has already been touched and will be broken soon, leading to the 76.4% retracement level at 0.85480. Furthermore, the pair are trading below all three ema bands, while the stochastic indicator points lower.
Chart: EUR/GBP Daily Time Frame ( April – December 8 , 2017)
You can check out our latest Q4 trading forecast for Sterling here.
--- Written by Nick Cawley, Analyst.
Follow Nick on Twitter nickcawley1.
Gold Prices Off Key Support - FOMC Rally Eyes Initial Resistance Hurdles.
Short term trading and intraday technical levels.
Fundamental Forecast for Gold: Neutral.
Gold prices respond to critical support; post-FOMC rally under review W hat’s driving gold prices? Review DailyFX’s 4 Q Gold Projections Join Michael for Live Weekly Strategy Webinars on Mondays at 12:30GMT to discuss this setup.
Gold prices snapped a three-week losing streak with the precious metal up 0.44% to trade at 1253 ahead of the New York close on Friday. The advance comes on the heels of the FOMC policy meeting and amid continued strength risk markets with the all three major U. S. equity indices poised to close higher on the week.
The FOMC raised interest rates by 25bps as expected this week with the updated quarterly projections showing an upwardly revised print on forecasts for both GDP and employment (unemployment down to 3.9% from 4%). Interestingly enough, expectations for the Core Personal Consumption Expenditure (PCE) remained unchanged at 1.9%, just shy of the central bank’s 2% inflation target.
This suggests that while growth prospects remain firm, the central bank continues to expect subdued underlying price growth to carry over into next year. With inflation remaining the laggard of the Fed’s dual mandate of price stability and full employment, the committee will likely be in no hurry to aggressively hike rates next - a positive for the yellow metal. Heading into next week, the focus is on a break of a key range between 1240-1267 as we look for further signs of basing in gold prices.
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A summary of IG Client Sentiment shows traders are net-long Gold - the ratio stands at +4.33 (81.3% of traders are long)- bearish reading Long positions are 1.6% lower than yesterday and 0.4% higher from last week Short positions are 6.9% lower than yesterday and 14.7% lower from last week We typically take a contrarian view to crowd sentiment, and the fact traders are net-long suggests Spot Gold prices may continue to fall. Traders are further net-long than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger Spot Gold-bearish contrarian trading bias .
Last week we noted that gold prices had, “approached a key support confluence highlighted in our 4Q Gold Forecast at 1240/43 . This region is defined by the 61.8% extension of the decline off the yearly highs and the 50% retracement of the December advance with the long-term 200-week moving average converging on up-slope support just lower… Bottom line: from a trading standpoint I’d be looking for either evidence of an exhaustion low into this support zone OR a breach above yearly trendline resistance before tempting long exposure here heading into the Fed next week.”
Gold registered a low of 1236 before reversing higher with the advance now eying initial resistance at 1263/67 – a critical pivot zone. Subsequent topside objectives are eyed at 1285 (slope resistance / 100-day moving average) with a breach / close above 1295 would be needed to mark resumption of the broader uptrend. Such a scenario sees targets at the 2017 high-day close at 1346 backed by 1355 and the 2016 high close at 1366 .
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A closer look at near-term price action further highlights this support zone and heading into next week, the focus remains higher against this key threshold. A break below this threshold would shift the focus lower targeting 1219 & critical support / bullish invalidation at 1204/09 (an area of interest for exhaustion / long-entries IF reached).
Bottom line: We’ll be looking for further evidence that a near-term low may be in place. From a trading standpoint, our outlook remains weighted to the topside for now while above 1240.
---Written by Michael Boutros, Currency Strategist with DailyFX.
Follow Michael on Twitter MBForex contact him at mboutrosdailyfx or Clic k H ere to be added to his distribution list .
USD/CAD Resilience Vulnerable to Strong Canada Inflation Figures.
Central bank policy, economic indicators, and market events.
Fundamental Forecast for Canadian Dollar: Neutral.
USD/CAD trades near the monthly-high (1.2902) as the Federal Open Market Committee (FOMC) appears to be on course to further normalize monetary policy in 2018, but a marked pickup in Canada’s Consumer Price Index (CPI) may rattle the near-term resilience in the exchange rate as it puts pressure on the Bank of Canada (BoC) to follow a similar path to its U. S. counterpart.
Fresh forecasts from Fed officials suggest the central bank will stay on its current course of delivering three rate-hikes per year, and the hiking-cycle may prop up USD/CAD over the near-term especially as the BoC endorses a wait-and-see approach for monetary policy.
With Fed Fund Futures showing budding expectations for a March rate-hike, the pair stands at risk for a more meaningful recovery going into the end of 2017, but key data prints coming out of Canada may spark a bearish reaction in the dollar-loonie exchange rate as the headline reading for inflation is expected to climb to an annualized 2.0% from 1.4% in October.
The threat for above-target inflation may heighten the appeal of the Canadian dollar its raises the risk of seeing Governor Stephen Poloz and Co. adopt a more hawkish tone in 2018, and the central bank may increase its efforts to prepare Canadian households and businesses for higher borrowing-costs as officials note ‘ higher interest rates will likely be required over time .’ On the other hand, a below-forecast CPI print may fuel the near-term resilience in USD/CAD as it raises the BoC’s scope to retain the current policy for the foreseeable future. Interested in having a broader discussion on current market themes? Sign up and join DailyFX Currency Analyst David Song LIVE for an opportunity to discuss potential trade setups!
USD/CAD Daily Chart.
Near-term outlook for USD/CAD remains clouded with mixed signals as the pair marks a failed attempt to test the monthly-high (1.2902), with the pair stuck in a narrow range as the 1.2620 (50% retracement) region offers support. Keep in mind, the Relative Strength Index (RSI) highlights a similar dynamic as it struggles to push back into overbought territory, but the broader outlook remains supportive as the oscillator preserves the bullish formation carried over from August.
With that said, topside targets remain on the radar for USD/CAD, with a break of the near-term range raising the risk for a move back towards the 1.2980 (61.8% retracement) to 1.3030 (50% expansion) region. Want to learn more about popular trading indicators and tools such as the RSI? Download and review the FREE DailyFX Advanced Trading Guides !
Australian Dollar May Have Risen As Far As It’s Going This Year.
Financial markets, economics, journalism and fundamental analysis.
Fundamental Australian Dollar Forecast: Neutral.
The Australian Dollar got a boost from the general US Dollar weakness engendered by the Fed Then blockbuster local data helped the bulls cause even more This week won’t offer them similar opportunities however.
Just getting started in the AUD/USD trading world? Our beginners’ guide is here to help.
The Australian Dollar was borne aloft last week by updrafts foreign and domestic.
It was helped by the general US Dollar weakness which followed Wednesday’s monetary policy call from the Federal Reserve. While the Fed was far from dovish, it did stick with its central prescription of three interest rate hikes in 2018. Rightly or wrongly there were clearly those who wanted to hear of more and the greenback struggled when they didn’t.
But that wasn’t the Aussie Dollar’s only prop. Australian data came charging home in very sprightly fashion too. Consumer confidence hit four-year highs according to a monthly snapshot from major lender Westpac . Then came news that the Australian economy added more than 61,000 jobs in November, blowing expectations for an already chunky 19,000 clean away. This was the strongest monthly showing since October 2015, with full-time employment growing encouragingly.
Given all of the above, it’s no wonder that the Aussie rose.
But what of the coming week? Well, it will contain the last trading sessions before markets head into the Christmas break. This could make for thinner trading and exaggerated moves. It may also be that investors will rethink that immediate Fed reaction, re-learn the clear fact that the US central bank remains the most hawkish developed-market monetary authority by a country mile and buy the Dollar back a bit.
It’s certainly much more hawkish than the Reserve Bank of Australia.
Don’t forget that that last US rate hike finally eroded the Australian Dollar’s long-held yield advantage over the greenback, putting the upper limit of the Fed funds target band at 1.50%- the same as Australia’s record-low official cash rate. The Fed may only be set to hike rates three times in the coming year, but that’s still three more times than the RBA will do so, according to current futures-market pricing.
The USD side of AUD/USD is all too likely to dominate but much may depend on the week’s most significant Australian news release, the RBA’s policy meeting minutes from December 5. In recent pronouncements the central bank has seemed a bit less worried about inflation’s weakness and a bit less inclined to worry aloud about the baleful effects of Australian Dollar strength on its inflation-targeting mandate.
To be sure it still mentions both, but not with the urgency it once did. If the minutes show it in similarly relaxed frame of mind about both, the Australian Dollar could score some more gains, but overall a more neutral tone is probably likely for AUD/USD.
This note was originally published on December 15, 2017.
--- Written by David Cottle, DailyFX Research.
Contact and follow David on Twitter: DavidCottleFX.
The New Zealand Dollar and The Tides of Change Ahead of the RBNZ.
Price action and Macro.
Fundamental Forecast for NZD: Bearish.
The New Zealand Dollar spent much of this week clawing back losses that had very much dominated the currency’s price action over the past few weeks. Bigger picture, we can really draw back to July to focus in on when the pain really started to show for the Kiwi. This is when NZD/USD was trading over the psychological level of .7500, and this came on the heels of an aggressive rally that took two-and-a-half months to build-in over 700 pips on the pair. But in the three months since, the entirety of those gains have been eradicated. This bearish move in the New Zealand Dollar saw another fresh wave of selling on last month’s news around New Zealand elections, and after catching a bounce at the 2017 low last week, prices spent most of this week trudging-higher.
NZD/USD Daily: Corrective Gains for the Kiwi After Last Week’s Bounce at 2017 Low.
After newly-installed Prime Minister Jacinda Ardern’s Labour party crafted a coalition with the NZ First Parties, a blip of strength had temporarily showed-up in the Kiwi spot rate . This was very much driven by the prospect of an increase in the minimum wage; with the hope being that higher wages as brought upon by legislation could force stronger rates of inflation which, eventually, can put the Reserve Bank of New Zealand in a spot where they have to hike rates. But – that strength was short-lived, as Ms. Ardern is also promoting a modification to the Reserve Bank Act, and this can radically change the way that the RBNZ does business.
The proposed change would make the RBNZ also accountable for full-employment . This would be the incorporation of an additional mandate, on top of the RBNZ’s current focus of inflation. The change would effectively put the RBNZ in a spot where they have to try to balance the forces of inflation and employment, similar to the Federal Reserve utilizing a dual mandate versus the single mandate of Central Banks like the ECB. This is also happening while lawmakers consider an additional committee to manage the cash rate, and this invites a whole host of uncertainty around the future of the Kiwi-Dollar spot rate, along with that of the RBNZ itself.
On top of all of that potential change, next week sees Interim RBNZ Governor Grant Spencer conduct his first full monetary policy statement, and this also happens to be the first RBNZ rate decision under the new Labour-led government. There are no expectations for any moves on rates, and for the next expected adjustment, markets are currently looking out to Q4 of 2018 for a potential hike. The one possible area for change at next week’s rate decision is an adjustment to inflation expectations in order to account for the weaker currency. In Graeme Wheeler’s final press conference as the head of the bank in August, the RBNZ said that they anticipate rates staying on hold until at least September of 2019. Since then, we’ve seen inflation come-in at 1.9% versus the RBNZ’s projection of 1.6%, and the additional slide in NZD will likely necessitate a small adjustment for forward-looking inflation figures.
While stronger rates of inflation could eventually drive rates-higher, the prospect of change within the Reserve Bank Act will likely continue to dampen demand for NZD, at least in the near-term, as the rest of the world becomes more familiar with what a Jacinda Ardern-led New Zealand will end up looking like. The one thing that does appear certain is that Ms. Ardern is not satisfied with business as usual, and this can lead to further change. Markets, generally speaking, abhor change as this presents risk; and while the potential around those changes remain uncertain, we will likely see some element of risk aversion until market participants can gain more clarity. The forecast for next week will be set to bearish on the New Zealand Dollar.
--- Written by James Stanley , Strategist for DailyFX.
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