By Danica Hanpton

It's been an extremely whippy night in currency markets, the NZD/USD traded violently within a 0.7080-0.7180 range.

The first half of the night was all about US strength. The stronger USD bias was fuelled by speculation that the recovering US economy would see the Fed hike rates sooner than previously anticipated. USD sentiment was also helped by ECB President Trichet warning about the possibility of further bank write-downs in the Eurozone and Standard & Poor's negative views on Greece and Portugal. Against a generally stronger USD, most currencies were sent reeling. NZD was no exception, falling from above 0.7180 to nearly 0.7080.

However, the USD strength didn't last as comments from Fed Chairman Bernanke cooled speculation about near-term Fed rate hikes. Bernanke acknowledged the signs of improvement in the US economy, but warned that the US economy still faced formidable headwinds. Perhaps more importantly, Bernanke said the FOMC is still looking at US interest rates remains low for an "extended period".

In reaction, US interest rates dropped (US 2-year government bond yields slipped 5bps to 0.78%) and the USD was sold heavily. As the USD reversed all of its earlier strength, NZD/USD surged back up towards 0.7180.

Squint your eyes through last night's volatility and NZD/USD is just a smidge lower than where it started the week. This week's key NZ event remains 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, we look for the 90-day track to imply a probable first hike in Q3. A "steady she goes" attitude from the RBNZ should see NZD/USD struggle to break above last week's high of around 0.7300, even if the USD weakness resumes this week.

For today, the backdrop of a weaker USD should mean that dips in NZD/USD are limited to 0.7135-0.7140. On the topside, initial resistance is expected around 0.7180-0.7190.

It's been a night of violent moves in global currency markets.

The first half of the night was characterised by a generally firmer USD. The USD Index climbed to a 1-month high above 76.00, bolstered by speculation that the recovering US economy will see the Fed raise interest rates sooner than previously anticipated.

Against a generally stronger USD, EUR/USD plunged from above 1.4900 to around 1.4760. However, rumoured demand from sovereign accounts provided some support ahead of 1.4750.

EUR sentiment was also dented by comments from ECB President Trichet, who endorsed a strong USD and warned that investors were right to be cautious about future bank write-downs in the Euro area. Ratings agency Standard & Poor's also downgraded the outlook on Portugal's sovereign credit rating to negative and put Greece on negative credit watch.

However, sentiment turned on a dime. The second half of the night was dominated by USD weakness after Fed Chairman Bernanke hosed down rate hike expectations.

While Bernanke acknowledged the US economy is showing signs of improvement, he said "we still have some way to go before we can be assured that the recovery will be self-sustaining". Bernanke also added that the FOMC is still looking at interest rates remaining low for an "extended period".

In reaction, US interest rates dropped. Market pricing is now consistent with very little chance of the Fed raising rates before the middle of 2010 (recall yesterday market pricing suggested there was nearly a 50% chance of the Fed hiking 25bps in April). The US 2-year government bond yield fell 5bps to 0.78%.

Bernanke's reassurance that US interest rates will remain low for a while yet provided some support to both commodity and equity prices. Gold prices rebounded swiftly from sub-US$1,140 to above US$1,160/oz and the S&P500 is currently up 0.2%.

In currency markets, the knee-jerk reaction to Bernanke's comments was to sell USD. EUR/USD rebounded from around 1.4780 to nearly 1.4880 and GBP/USD rebounded from sub-1.6350 to nearly 1.6475.

The JPY was the only currency that managed to buck the "ups" and "downs" seen in the USD last night. Despite the violence seen elsewhere in currencies, USD/JPY steadily ground lower, falling from above 90.00 to nearly 89.00.

* Danica Hampton is BNZ's Senior Currency Strategist. All of the research produced by the BNZ Capital team of economists is available here.