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FX markets second guess rate decisions as central banks head for neutral

The number of currencies for which markets are trading interest-rate expectations rather than actual rate decisions is a reminder of the power of market sentiment.


When the Reserve Bank of New Zealand raised interest rates by 50 basis points in April while most of the street economists were looking for a 25bp increase, the NZD sold off. In contrast, the Bank of Canada hiked by 50bp as widely expected and the CAD rallied.

According to BNP Paribas, this challenges the conventional belief that front-end rate differentials are the main drivers of FX. In a recent research note, the bank’s G10 FX strategist observed that markets were longer the CAD than the NZD ahead of their respective central bank decisions and concluded that markets were trading expectations regarding the level of terminal rates in this cycle.

Dominic Bunning, head of European FX research at HSBC, says the most obvious examples of currencies moving more in line with changes further out along the curve or the terminal rate include GBP, which has failed to benefit despite higher front-end pricing as the swap curve has inverted beyond the one- to two-year point.

The Fed and dollar cycle are driving G10 trends
Kenneth Broux, Societe Generale

“The NZD also failed to benefit from some of the 50bp rate hike delivered in this cycle when the Reserve Bank of New Zealand left its projections for the terminal rate largely unchanged,” he explains.

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