The post March 09 MPS $NZ bounce

Realising that I am probably low on content Bill Bennet (his blog) gave me a question to write a post on:

Why did the NZ$ shoot up against the A$ when the official NZ interest rate dropped below Australia’s? The declared rate was pretty much the one anticipated and the $’s climb was dramatic.

There are two primary reasons:

  1. The recovery in the US market which was “increasing risk aversion” (yuck) at a similar time (and we are a “riskier dollar”),
  2. The distribution of expectations surrounding the rate cut.

Here is a picture with the bounce:


Source (NBNZ)

And below is the email I sent discussing the expectations issue.

The market was “expecting” a 70bp cut prior to the result. Now this didn’t actually mean the market expected a 70 point cut – it just meant that they were expecting some chance of a 50, some chance of a 75, and some chance of a 100.

Now when the Bank delivered a 50bp cut it meant that there was no longer a chance of a 75 or a 100 – so 90 day bill rates (which had been low given the “chance” of a bigger cut) went up. Higher 90 day bill rates attracted people back in to NZ for some short term lending, which combined with normal currency trading (edit this can be seen as a “focal point” type argument) led to a climb in the dollar.

So even though people were expecting a 50 overall – the fact that it “could have been higher” had driven down the dollar a bit – something that unwound and drove the dollar up.

Furthermore, the Bank was pretty solid on the idea that 2.5% was THE END – lowering the possibility that rates could head lower. This would have contributed to the steep increase.

  • Which market? Didn’t iPredict have higher prices on its 0.50 contract than its 0.75 contract?

  • “Which market? Didn’t iPredict have higher prices on its 0.50 contract than its 0.75 contract?”

    Indeed it did – by a long way 🙂

    However, if you had to come up with a simple sample statistic that measured the probabilities associated with the decision ex-ante I think iPredicit would have “expected a 70bp cut” itself.

    The “70 bp cut” was just the market place saying that it put x% on 50, y% on 75, and z% on 100. If I remember correctly iPredict had around 50% on 50 25% on 75 and 25% on 100. That would be a market price of about 68.75% …