FxWirePro: Spotlight On RBNZ Preview, Bid 3m Skews And Hedge EUR/NZD Via FX Derivatives Strategies On Coronavirus Threats

The deadly coronavirus has adversely affected almost of walks of lives in China. Amid such a lingering threat, the outbreak of a novel coronavirus (2019-nCoV), which originated in the central Chinese city of Wuhan, has now been declared a global emergency by the World Health Organization. The virus has already spread to the extent that it will have adverse impact on China's economy and New Zealand is much exposed to China as they are the major trade partners of Kiwis.

Ahead of RBNZ’s monetary policy, Kiwis dollar could continue to slide further for this week, as EUR is less sensitive to coronavirus news than is the NZD. Against that, there’s plenty of data on the EZ economy this week which could indicate a still sluggish economy. 

The cyclical cocktail for NZD includes a somewhat more supportive global backdrop, but tightening domestic financial conditions that will require more action from the RBNZ. Our central forecast for 2 more RBNZ cuts would see rate spreads vs USD hit historical extremes, though the exchange rate will be insulated to an extent by a still-elevated terms of trade, as well as balance of payments positives as the local earnings of Australian parent banks are retained under the RBNZ’s new capital regime. 

The last significant data point for NZ was the 3Q GDP result. Growth was reasonable at 0.7%q/q, but came with a significant downward revision to 2Q, from 0.5%q/q to 0.1%q/q.

As a result the annual rate of growth still printed at a low-side 2.3%oya. This is below the RBNZ’s (downwardly-revised) estimates of potential growth (refer 1st chart).

In our view, the annual rate of growth smooths through all this and conveys the story best, in that the economy still is struggling to break out of its recent downshift. This leaves the central bank's output gap objectives unresolved into 2020.

OTC outlook and Hedging Strategy: 

Please be noted that the positively skewed IVs (implied volatilities) of 3m tenors signify the upside risks (refer 2nd chart). Bids for OTM calls strikes up to 1.75 levels are observed ahead of RBNZ monetary policy that is scheduled for this week to indicate hedgers’ interests for upside risks.

Contemplating all the above factors, we advocate 3m (1%) in the money delta call options.

Thereby, in the money call option with a very strong delta will move in tandem with the underlying spot fx.

Alternatively, with an objective of arresting upside risks in the months to come, we advocate initiating fresh long build ups in EURNZD futures contracts of mid-month tenors on hedging grounds. Courtesy: Sentry & JPM