NZD/USD depreciates on risk aversion, edges lower to near 0.6120 ahead of Fed decision

• NZD/USD loses ground as traders adopt cautious stance ahead of Fed decision.
• The risk-off sentiment provides support for the US Dollar.
• RBNZ’s Paul Conway pushed back on expectations for rate cuts.

NZD/USD halts its two-day winning streak, trading lower around 0.6120 during the Asian session on Wednesday. The prevailing risk-off sentiment is exerting additional downward pressure on the NZD/USD pair as market participants exercise caution amid heightened tensions in the Middle East. There are expectations that the administration of US President Joe Biden may authorize military strikes in response to a recent drone attack on a US outpost in Jordan.

In terms of economic indicators, the ANZ Business Confidence report indicates an improvement in the business outlook in New Zealand, rising to 36.6 in January from the previous reading of 33.2. However, the ANZ Activity Outlook registered a slight decrease, coming in at 25.6% compared to the prior reading of 29.3%.

However, the Reserve Bank of New Zealand (RBNZ) Chief Economist Paul Conway has taken a hawkish stance, pushing back on expectations for rate cuts. In his statement on Tuesday, Conway signals a cautious but optimistic outlook on the effectiveness of current monetary policy measures.

The US Dollar Index (DXY) encounters a challenge due to the downbeat United States (US) Treasury yields. The Federal Open Market Committee (FOMC) is widely expected to keep interest rates within the range of 5.25–5.50% in its Wednesday meeting. In the Federal Reserve's (Fed) December meeting, officials anticipated three rate cuts in 2024. Market participants are eagerly anticipating signals from Fed Chairman Jerome Powell.

Rate swap markets have seen a gradual extension of expectations for rate cuts, with the CME’s FedWatch Tool indicating a 43% probability of the first-rate cut from the Fed in March. In contrast, back in December, swaps initially implied an over 80% chance of a rate trim in March. Additionally, there is a 53% chance of a 25 basis points rate cut in May. Investors will be closely monitoring the US ADP Employment Change on Wednesday, ahead of the US Nonfarm Payrolls report later in the week.