NZD/USD slumps from 0.6250 as US Dollar strives to gain ground

NZD/USD drops from 0.6250 as the market sentiment turns cautious.
The US Dollar bounces back ahead of Fed Harker’s policy announcement.
Traders expect the Fed to reduce interest rates further by 75 bps in the remainder of the year.

The NZD/USD pair faces selling pressure above the crucial resistance of 0.6250 in Friday’s North American trading hours. The Kiwi asset drops as the US Dollar (USD) attempts to gain ground above the annual low. The US Dollar Index (DXY), which tracks the Greenback’s value against six major currencies, bounces back from the annual low of 100.20 to near 100.90.

Market sentiment turns cautious as investors shift focus to global PMI data, which will be published on Monday. The S&P 500 opens on a bearish note, indicating a decline in investors’ risk appetite. The cautious market mood has also weighed on risk-perceived currencies, such as the New Zealand Dollar (NZD).

Growing uncertainty over the Federal Reserve’s (Fed) interest rate outlook has made market sentiment cautious. The Fed delivered its first interest rate cut decision in more than four years on Wednesday, in which it reduced its key borrowing rates by 50 basis points (bps) to 4.75%-5.00%. Fed policymakers projected the federal fund rate to decline to 4.4% by year-end. Also, comments from Fed Chair Jerome Powell at the press conference signaled that the policy-easing cycle wouldn’t be aggressive.

On the contrary, traders expect that the Fed’s rate-cut cycle will be more aggressive than other central bankers. The CME FedWatch tool shows that the Fed will cut borrowing rates further by 75 bps in the remaining two meetings this year, suggesting that there will be one more 50 bps rate cut.

Meanwhile, the NZ Dollar could face selling pressure due to deepening growth concerns. The NZ economy contracted by 0.2% in the second quarter of the year and its economic outlook is also vulnerable. However, the pace at which the economy contracted was slower than the expected pace of 0.4%.

Risk sentiment FAQs

What do the terms'risk-on' and 'risk-off' mean when referring to sentiment in financial markets?

In the world of financial jargon the two widely used terms “risk-on” and “risk off'' refer to the level of risk that investors are willing to stomach during the period referenced. In a “risk-on” market, investors are optimistic about the future and more willing to buy risky assets. In a “risk-off” market investors start to ‘play it safe’ because they are worried about the future, and therefore buy less risky assets that are more certain of bringing a return, even if it is relatively modest.

What are the key assets to track to understand risk sentiment dynamics?

Typically, during periods of “risk-on”, stock markets will rise, most commodities – except Gold – will also gain in value, since they benefit from a positive growth outlook. The currencies of nations that are heavy commodity exporters strengthen because of increased demand, and Cryptocurrencies rise. In a “risk-off” market, Bonds go up – especially major government Bonds – Gold shines, and safe-haven currencies such as the Japanese Yen, Swiss Franc and US Dollar all benefit.

Which currencies strengthen when sentiment is 'risk-on'?

The Australian Dollar (AUD), the Canadian Dollar (CAD), the New Zealand Dollar (NZD) and minor FX like the Ruble (RUB) and the South African Rand (ZAR), all tend to rise in markets that are “risk-on”. This is because the economies of these currencies are heavily reliant on commodity exports for growth, and commodities tend to rise in price during risk-on periods. This is because investors foresee greater demand for raw materials in the future due to heightened economic activity.

Which currencies strengthen when sentiment is 'risk-off'?

The major currencies that tend to rise during periods of “risk-off” are the US Dollar (USD), the Japanese Yen (JPY) and the Swiss Franc (CHF). The US Dollar, because it is the world’s reserve currency, and because in times of crisis investors buy US government debt, which is seen as safe because the largest economy in the world is unlikely to default. The Yen, from increased demand for Japanese government bonds, because a high proportion are held by domestic investors who are unlikely to dump them – even in a crisis. The Swiss Franc, because strict Swiss banking laws offer investors enhanced capital protection.

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