FxWirePro: Better data but falling real rates and tightening credit keep us bearish in NZD – Diagonal strips to pawn positive skews in smart hedge

The December’s highs of (0.7215) and an interim retracement in the 0.7240-50 area still attract but the push above 0.7200 is not accelerating. A slip now below 0.7180 could trigger a flush back to 0.7075-90.

NZD/USD medium term perspectives:  Slide up to 0.68 levels cannot be disregarded. The US dollar has had a remarkable bounce since the US polls and has potential to rise further in the months to come. The Fed’s assertive tightening projections plus US fiscal expansion should maintain upside pressure on US interest rates and the US dollar. Against that, the NZ economy is strong and dairy prices have risen, but these forces are subservient to the US dollar’s trend.

We expect NZD to fall through this year, reaching 0.62 at year-end. The support to growth from migration will fade, while the RBNZ at the least are likely to hold rates steady as inflation normalizes, pushing real rates materially lower we think.

The economy is also subject to credit tightening through numerous channels: macro-prudential constraints, widening mortgage rate spreads, and banks’ discretionary tightening of credit criteria to businesses. This creates the space-or the need-for the OCR to fall and drag NZD with it while preserving monetary conditions.

OTC outlook and hedging framework:

Although the Kiwi dollar surged a bit in the recent times but sensing more bearish pressures in the upcoming future especially after data showed that China’s imports dropped far more than expected last month and as the greenback remained supported by Hawkish US central bank’s tone. You could notice OTC market discounting these factors in 1m IV skews (they bid for OTM put strikes).

Well, to mitigate the further bearish risks, at spot reference 0.7218 we reckon the NZDUSD options strips with narrowed strikes.

Hence, we advocate longs in 2 lots of 2m -0.49 delta put options, while buying 1 lot of +0.51 delta calls of 2w expiry.

Even if the underlying spot goes against our anticipation, the underlying risk is properly mitigated regardless of swings, the strategy could also be utilized on speculating grounds as it is likely to fetch certain yields regardless of trend.