'Our tactical trade this week is to receive the 3mth 2yr swap at 3.99%. We expect another dovish shift from the RBNZ on Thursday morning'

(This is a trade note that Westpac has entered into, and why. It is not a recommendation to readers.)

By Imre Speizer

This is the first of a series of published tactical weekly trades, representing the combined views of our trading, sales and strategy teams.

The holding period is expected to be around one week, but is discretionary depending on fresh developments. Take-profit and stop-loss targets may similarly be be adjusted.

We will enter this trade today at 3.99%, which is 1bp above the current mid-level, if seen. The initial take-profit target is 3.90% and the initial stop-loss level is 4.03%. Carry and roll is around 2bp per month, worth knowing but  insignificant if we stick with our intended holding period.

Our rationale is that the RBNZ OCR Review on Thursday morning (9am NZT) could mark another dovish shift by the RBNZ.

Recall that in September, it reduced its interest rate forecast by around 50bp at the two-year ahead point. The October meeting will not include any forecasts, but the resulting press release is likely to contain significant tweaks to its policy guidance paragraph, the weak Q3 CPI outturn (1.0% yoy is at the bottom of the target band) a surprise to the RBNZ.

First, the signalled duration of the pause period will probably be extended. Second, the stated intention to resume tightening will probably remain but have conditions attached.

An outturn along the above lines will further encourage market chatter that the RBNZ is not merely on hold for a long time, but has completed its tightening cycle. Currently, the market has priced one 25 bp hike by Dec 2015, and another by Dec 2016. There is scope for this pricing to be pared. In addition, markets may price in the small probability of an adverse event causing an OCR cut, as the market has done in Australia.

Technically, the 3mth 2yr swap rate has major yield support at 3.98%. A break below that then targets head-and-shoulders support at 3.66%, well below our trade profit target but demonstarting potential nonetheless. That level is consistent with the market pricing out all remaing rate hikes during the next two years.

Admittedly, it has already fallen a long way since the peak in July, at 4.40%, which arguably means a bounce here could be larger than a further fall.

Our counter argument is that the probability of a market-hawkish outcome on Thursday is smaller than the probability of a market-dovish one. And again referencing technicals, momentum is pointing firmly downwards.

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The full Note is here.