By Mike Jones

The NZD has made a strong start to 2010. The combination of firming risk appetite and a generally weaker USD saw NZD/USD break above 0.7400 briefly last week.

On Friday, the release of December's US non-farm payrolls report occupied most of markets' attention. In contrast to market expectations for a flat result, the report showed US employers cut 85,000 jobs in December. US interest rates and the USD fell sharply in response, with the data seen as yet another reason for the Fed to maintain its ultra-loose monetary policy for a while yet. US 2-year Treasury yields were down 11bps and 10-year rates fell 7bps in the immediate wake of the data.

The retreating USD helped EUR/USD climb over a cent to 1.4400, while USD/JPY fell from above 93.50 to around 92.60.

Nevertheless, equity markets largely shrugged off the weaker payrolls report. November's employment numbers were revised up to a small gain and UPS raised its Q4 outlook. As a consequence, the S&P500 finished the night up 0.3%, after slipping lower early in the night. Our index of risk appetite (which has a scale of 0-100%) rose from around 66% to 67.7% - the highest reading since June 2008 and well above the long-run average of 50%.

Along with last week's widening in NZ-US interest rate spreads (3-year NZ-US swap spreads increased 7bps to 316bps), this has pushed the "˜fair-value' range implied by our short-term valuation model up to 0.7350-0.7550. This suggests that dips in NZD/USD below 0.7300 are unlikely to be sustained in the short-term.

If risk appetite remains buoyant and optimism about the 2010 global outlook continues, we'd expect a push higher in NZD/USD towards 0.7450-0.7500 in coming sessions. In terms of event risk, the local data calendar is relatively light this week. The highlight will probably be the QSBO business confidence survey on Tuesday. But November's building permits, due Thursday, will also be worth a look.

For today, initial NZD/USD headwinds are expected towards 0.7420, while solid support is expected on dips towards 0.7310.

The USD weakened against all of the major currencies on Friday night following a surprise drop in US employment. On a trade-weighted basis, the USD fell 0.5% last week "“ the largest weekly fall since late November.

According to Friday's non-farm payrolls report, US employers cut 85,000 jobs in December (leaving the unemployment rate unchanged at 10.0%). This was in stark contrast to the flat result analysts had expected. The weaker data tempered optimism about the US recovery, sending US interest rates lower. US 2-year Treasury yields fell around 11bps to 0.95%, while 10-year rates fell 7bps to 3.78%.

While the drop in US interest rates was a clear drag on the USD, the news was not all bad. November's payroll report was revised to a small jobs gain, and more timely data suggest the bigger picture for the US economy is one of steady economic recovery. Indeed, US stocks actually increased to new 15-month highs on Friday, having initially jagged lower on the weak payrolls report. UPS (regarded by some as a US economic bellwether) raised its fourth quarter outlook, adding to the positive mood. The S&P500 ended the night 0.3% higher, and finished the week up 2.7%.

Against the broadly weaker USD, EUR/USD surged over a cent to above 1.4400. There were no surprises from the final estimate of Eurozone Q3 GDP (it was left unrevised at 0.4% as expected). However, Q2 GDP was revised up to -0.1%, adding support to EUR.

Comments from new Japanese Finance Minister Kan supported a strengthening in the JPY. In contrast to Kan's previous call for a weaker JPY, Kan said on Friday currency levels should be determined by markets. This followed an apparent dressing down from Prime Minister Hatoyama who said "the government should basically not comment on foreign exchange".

Looking ahead, there is plenty of event risk to watch out for this week. The US Q4 corporate earnings season kicks off this week (Alcoa is due to report after the bell on Monday), which could be important in shaping equity market sentiment. Chinese trade data is released today, and the Fed's Lockhart is speaking on the US outlook. Later in the week European industrial production, the Fed's Beige Book, the ECB rate decision, US retail sales and industrial production, and Australian employment data are all due for release.

If the tone of global data continues to portend an improving global growth picture in 2010, we'd expect growth-sensitive currencies to outperform again this week.

* Mike Jones is a BNZ Currency Strategist. All of the research produced by the BNZ Capital team of economists is available here.