U.S. Dollar Rally Eases Pressure On Australian Policymakers

After talking for over a year about the overvalued nature of the Australian dollar, policymakers at the Reserve Bank of Australia are getting some much needed relief as the AUDUSD currency pair falls to multi-week lows on the back of rising interest rate hike speculation from the United States. After taking an extremely accommodative stance towards policy for the last several years after tumbling commodity prices forced a policy pivot, oddly enough, it is action on the US monetary policy front that is helping the RBA reach its own objectives.However, despite the near-term gains, traders are anticipating further action from the RBA before the year is out as the Central Bank is forced to contend with the impact of weak inflation.Now that a potential policy divergence is back in play, the stage might be set for significant downside in AUDUSD.

US Rate Hike Ambitions Offset Aussie Dollar Strength

Thanks to the more hawkish remarks of key Federal Reserve officials over the last week, the US dollar has snapped a month long retreat from July highs, once again climbing back to the upside on optimism that another rate hike will be implemented before year end. Aside from Yellen’s first speech in months at the Jackson Hole Symposium, her more hawkish sentiment was echoed by FOMC voting members including Vice Chairman Stanley Fischer who left the door open for two rate hikes before the end of 2016. Although futures are not pricing in a strong probability of two incremental increases before year end, the US dollar bought into the normalization narrative, moving back towards the middle of a range that has been intact since early 2015.While the Australian dollar has been resilient, especially after strengthening following the last rate hike, softness in the US dollar explains the recent reversal.

In dealing with inflation that is well below the RBA’s 2.00-3.00% annualized target, the Central Bank has been aggressive in cutting rates to spur spending and investment. To a degree, their efforts have paid off, with unemployment matching the lowest rates since 2013 and the economy experiencing the fastest pace of quarterly growth in three years according to 1stquarter GDP reports. However, the RBA has been unable to tackle low inflation and furthermore, accommodative policies have stoked concerns about a potential bubble in real estate. The strength in the Australian dollar has also been viewed as unwelcome by policymakers, especially as Australia works to stay competitive in a challenging trade environment and keep exports cheap. Although no more imminent adjustments to rates are anticipated, the potential divergence with the Fed which is intent on raising rates will likely eventually help reduce AUD strength.

Reversal In Play

From a technical perspective, several curious factors are emerging in the AUDUSD pair. For one, the upward trend in the pair beginning from May onwards was recently broken to the downside last week, providing an early indication of a reversal. Furthermore, the recent break below the 50-day moving average may signal that support for strength in the Australian dollar is waning. The next major level on the downside is 0.7450.If this level is broken to the downside, it could pave the way for a test of the 200-day moving average which is trending higher below the price action, also acting as support against a prolonged downturn in the pair. However, should AUDUSD change course and manage to reach new multi-month highs, it could set the stage for a continuation of a multi-month uptrend and a test of April highs.

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Although there is the possibility that the most recent price action is just merely a correction for the multi-month upward trend, especially after bouncing off the 38.20% Fibonacci level, should AUDUSD cross below 0.7382 which corresponds with the 61.80% Fibonacci level, it could confirm a trend reversal. Adding to the bearish bias from the trend line break and move below the 50-day moving average is the MACD indicator. Considering the signal line (orange) crossed over the MACD line (light blue) which has accompanied falling price action, additional pressure might be in store for AUDUSD. Finally, on a more near-term basis, the emergence of a downward trending equidistant channel formation could derail any hopes for a rebound in the pair with its underlying bearish bias.

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Looking Ahead

The major determinant of whether or not the Federal Reserve will opt to discuss raising rates during the September FOMC Meeting is the upcoming payroll data set to be delivered on Friday from the US Bureau of Labor Statistics. Another month of positive labor market data will probably provide the confirmation Central Bank officials need to begin the process of raising rates from current levels and stoke optimism about further rate normalization, helping the US dollar.However, should job creation miss expectations, it could send the US dollar sharply lower and delay any future action on monetary policy, helping AUDUSD rebound. With no major data due from Australia aside from retail sales, markets will be firmly focused on the upcoming US data, hurting the outlook for AUDUSD near-term as the US dollar reflects increased confidence in the outlook for US rates.