Opinion: Surprise Fed discount rate hike knocks Kiwi$ below 70USc

By Mike Jones The NZD staged a small recovery last week. Easing fears about the global recovery saw "˜growth-sensitive' currencies like NZD outperform. NZD/USD finished the week around 0.3% higher, a smidge under 0.7000. Global risk appetite received a clear lift following the release of the EU's plan to sort out Greece's fiscal woes. While an explicit bailout was ruled out, investors were at least provided with an expected timeline for Greece's deficit slashing plans. Our risk appetite index (which has a scale of 0-100%) rose from 52.7% to around 60% over the week, and NZD/USD jumped from 0.6950 to almost 0.7080. However, the burgeoning NZD recovery hit a speed bump on Friday in the form of the Fed's surprise decision to increase its discount rate, from 0.5% to 0.75%. While the move had been widely flagged, the timing caught markets off-guard. US interest rates and the USD soared as investors anticipated an earlier start to the Fed tightening cycle, sending NZD/USD back towards 0.6950. The NZD spent Friday night licking its wounds. A veritable chorus of Fed officials hit the wires slamming talk of earlier Fed rate increases as "overblown". Weak January US inflation data served to reinforce these sentiments. Having started the night in negative territory, US stocks finished the night around 0.2% higher (up 3.1% for the week), and NZD/USD drifted up to nearly 0.7000. For this week's local data schedule there is a broad mix of indicators. The highlight looks set to be Thursday's NBNZ business survey, with the RBNZ survey of inflation expectations, credit aggregates, merchandise trade and building consents data also all due for release. All up, we expect this week's data to show signs of ongoing economic recovery, even if a bit more caution creeps in. Such an outcome would ensure NZD remains well supported over the week. However, we suspect the resurgent USD will limit any bounces to the 0.7200 region in the short-term. As such, expect a bit more range trading in NZD/USD this week. The USD soared to 8-month highs (on a trade-weighted basis) on Friday afternoon following a surprise hike in the Fed's discount rate. However, around ¾ of these gains have since been unwound as Fed officials calmed speculation over earlier Fed rate hikes on Friday night. Markets were blind-sided on Friday by the Fed's decision to raise its discount rate (the level at which banks can access emergency funding) 25bps to 0.75%. While the Fed took great pains to stress the move did not represent a tightening of monetary policy, markets begged to differ. Investors interpreted the move as an important (but not the first) step towards policy 'normalisation', which should pave the way for Fed rate increases down the track. Markets' speculation over an earlier withdrawal of the Fed's monetary stimulus (current pricing implies a Fed Funds rate of 0.5% by November), lit a rocket under the USD. EUR/USD fell from 1.3620 to around 1.3450, GBP slumped over a cent to nearly 1.5400, and USD/JPY jumped from 91.20 to above 92.00. However, the USD pared some of its gains during Friday's offshore session. St. Louis Fed President Bullard said the idea of the Fed increasing rates this year is "overblown." And New York Fed President Dudley said the Fed's pledge to keep rates low for an extended period "is still very much in place." These sentiments were reinforced by January's weaker-than-expected US CPI data. Prices excluding food and energy fell for the first time in 27 years (-0.1%m/m vs. +0.1% expected). As a result, most of the major currencies shook off some of their earlier losses; EUR/USD returned to around 1.3600 and USD/JPY dribbled back to 91.50. A notable exception was GBP. January retail sales carried on the terrible run of recent UK data, falling 1.2%m/m compared to forecasts of -0.5%. Fears over a double-dip recession for the UK weighed on GBP, and GBP/USD plumbed 9-month lows of almost 1.5350. Looking ahead, we suspect the firming USD will provide headwinds for the major currencies this week. However, there is plenty of event risk to watch out for. Further evidence of the degree of divergence among the world's major economies will be provided by Q4 GDP estimates for the US, the UK and Germany. The Fed will be in focus again with plenty of Fed officials due to speak and chairman Bernanke set to deliver his semi-annual address to the US Senate. In addition, keep an eye out for the results of Greece's latest sovereign bond auctions. Disappointing results will bring concerns over Greece's fiscal woes back to the fore, after fading towards the end of last week. * Mike Jones is a BNZ Currency Strategist. All of the research produced by the BNZ Capital team of economists is available here.