Opinion: US$ strengthens vs NZ$ on talk Fed may hike early

By Danica Hampton NZD/USD spent most of Friday night trading within a 0.7140-0.7280 range. The NZD/USD opened the offshore session near 0.7250 and hit its highs immediately after the US non-farm payrolls report. The surprisingly strong US employment report (payrolls fell just 11,000 in November, well below the 125,000 drop forecast) triggered a sharp rise in US interest rates (as investors brought forward the timing of anticipated Fed rate hikes) and sparked a sharp rebound in the USD. Before long, NZD/USD skidded through 0.7200 and found a base just below 0.7150. Weekend media reports suggesting that China hasn't made substantive changes to its foreign reserve strategy and that the USD remains its key currency, will likely help the USD start the week on a firm footing. Locally, the key focus this week is Thursday's RBNZ decision. With things progressing broadly in line with its expectations, we suspect the RBNZ will remain comfortable reiterating that the OCR will remain at 2.50% until the second half of next year. Specifically, look for the 90-day track to imply a probable first hike in Q3. Aside from the RBNZ, the week also brings a clutch of Q3 GDP indicators. The wholesale trade and manufacturing releases will likely show signs of stabilisation, but construction is still expected to struggle. We'll also see November's electronic card transactions and the manufacturing PMI reading (which will likely remain in the 50-plus territory). We suspect the NZD/USD will struggle towards 0.7300 this week. Not only is the USD likely to remain on a firm footing thanks to reinvigorated Fed hike expectations, but the RBNZ is expected to reiterate that the OCR will remain low until well into next year. NZ-US 3-year swap spreads narrowed 27bps to 3.14% last week and this will likely undermine the NZD/USD. It's worth noting, the sharp narrowing of NZ-US interest rate differentials has seen the "˜fair value' range from our short-term valuation model fall from 0.7300-0.7500 to 0.7150-0.7350 over the past week. The USD climbed against all major currencies on Friday night as investors digested shockingly strong US non-farm payrolls data. The US economy shed just 11,000 jobs in November and the unemployment rate fell to 10.0% from 10.2%. This was far better than the 125,000 job losses forecasted by economists for the month. The shockingly good employment report sent US interest rates higher as investors brought forward the anticipated timing of the first Fed rate hike. Market pricing is now consistent with nearly a 50% chance of the Fed hiking in April and the Fed Funds rate close to 1.00% by the end of 2010. US government bond yields rose 11bps to 0.83% on Friday and finished the week up 15bps. US equity markets also advanced on Friday night. Sectors sensitive to the economic cycle (like industrials, technology, consumer and financials) were the strongest performing stocks. However, commodity-related stocks were weighed down by the slide in commodity prices (gold fell 3.7% to US$1,161/oz). At one point, Wall Street was up 1.5-2.0%, but the S&P500 closed up 0.55%. Despite the modest gains seen in equities, the prospect of sooner-than-anticipated Fed rate hikes encouraged investors to trim back short USD positions. As a result, the USD Index surged 1.7% to nearly 76.00 "“ its highest level in about a month. EUR/USD fell from above 1.5050 to below 1.4850 and USD/JPY rose from sub-88.50 to above 90.50. Weekend media reports suggesting China hasn't made massive changes to its foreign reserve strategy and that the USD remains its key currency, will likely help the USD start the week on a firm footing. The moves seen in currencies last week suggest the risk-appetite focus that has driven USD moves over the direction over the past year may be fading. USD/JPY gained some 4% after the Bank of Japan expanded its quantitative easing program (and Japanese interest rates fell). EUR/USD struggled to make further headway after ECB President Trichet hosed down near-term tightening expectations by describing Eurozone rates as "appropriate". And Friday's stronger-than-expected US non-farm payrolls and hawkish shift in Fed expectations supported the USD. We suspect that relative growth prospects and diverging economic fundamentals will have a greater role to play in driving currencies in 2010. This means we may actually start to see the USD benefit from upside surprises in US data rather than fall due to rising risk appetite. Key economic events to watch this week include, Fed Chairman Bernanke's speech tomorrow morning, the UK's pre-budget report and the Bank of England decision on Thursday. * Danica Hampton is BNZ's Senior Currency Strategist. All of the research produced by the BNZ Capital team of economists is available here.