article 3 months old

Australian Dollar May Turn

Currencies | Mar 14 2016

By Ilya Spivak, currency strategist, FXCM

Fundamental Forecast for the Australian Dollar: Neutral

  • Australian Dollar surged to 11-month high vs. US counterpart last week
  • Hawkish cues in FOMC announcement may hurt risk appetite, sink Aussie
  • Soft employment figures may rekindle RBA interest rate cut speculation

The Australian Dollar continued to press upward last week, rising to the highest level in 11 months against its US counterpart. The velocity of the move has been undeniably impressive: prices have now completed the biggest two-week rally in 4.5 years. Favorable risk appetite trends fueled the latest advance. Share prices continued to recover from lows set in mid-February, spurred on by aggressive expansion of ECB stimulus. The S&P 500 stock index – a benchmark for global sentiment – has now nearly erased its year-to-date decline.

Risk trends are likely to remain central in the week ahead as the Federal Reserve takes it turn to deliver a monetary policy announcement. This time around, the policy statement will be accompanied by an updated set of economic forecasts and interest rate projections as well as a press conference with Chair Janet Yellen. A rate hike is almost certainly not in the cards: Fed Funds futures imply a 96.1 percent probability of staying within the current 25-50 basis point range for the benchmark lending rate. This puts the onus on forward guidance and mismatch between the central bank’s outlook and that of the markets.

Investors have been decidedly more pessimistic than Fed officials. When the FOMC projected four rate hikes in 2016 as it issued its first post-QE increase late last year, priced-in expectations envisioned just two. The subsequent turmoil in financial markets through the first quarter hasn’t helped matters. Traders briefly abandoned bets on even one 25bps up move in mid-February. The outlook has recovered a bit alongside stock prices and the markets now put the Fed Funds rate at 67bps by year-end, meaning they see one hike from the current setting into the 50-75bps range.

For its part, the Fed has continued to make progress on its mandate. Since the start of the year, the unemployment rate has dropped to 4.9 percent, the lowest in eight years. Meanwhile, the core PCE gauge of inflation – the Fed’s favored price growth indicator – jumped to 1.7 percent in January, the highest in three years and within a hair of the Fed’s target of 2 percent. Most critically, this happened before the start of a pullback in the US dollar and a rebound in crude oil prices in early February. Both have been important headwinds for prices. While explicit energy costs are factored out of core inflation data, its impact still bleeds into the reading because it is an input in the production of many other goods.

On balance, this means that the US central bank has a compelling argument to tighten further. Tactically speaking however, doing so this time around seems unwise. The disconnect between the Fed’s view and that of investors means tightening now would probably trigger panic. Market participants will have to be pushed to acclimate to further stimulus withdrawal however, meaning the FOMC shall have to fine-tune its language to be both reassuring and decidedly more hawkish than status-quo bets envision. This will probably weigh against risk appetite as portfolios adjust, sending the Aussie Dollar lower alongside share prices.

February’s Employment report takes top billing on the domestic front, with a net 12k jobs gain expected. This would mark an improvement from January’s 7.9k job loss but fall short of trend averages running above 20k/month. Furthermore, Australian news-flow has tended to underperform relative to consensus forecasts over recent weeks, opening the door for a downside surprise. The RBA has maintained a neutral data-dependent posture, a stance likely to be reinforced in minutes from the March policy meeting to be released next week. With that in mind, a soft result may rekindle near-term rate cut speculation, compounding any sentiment-driven weakness facing the Aussie.

Reprinted with permission of the publisher. The above story can be read on the website here.

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