When a currency fails to move in the expected direction, it is more likely to head the other way. Unfortunately, neither the RBA’s hawkish rhetoric nor the rallies in the S&P 500 and the yuan are providing much support for the AUD/USD pair. Let’s take a closer look and develop a trading plan.
The article covers the following subjects:
Major Takeaways
- The RBA kept the cash rate at 4.35%.
- The AUD/USD is lagging behind the S&P 500 rally.
- US corporate earnings are fueling inflation.
- Weak CPI data could provide an opportunity to sell AUD/USD, targeting 0.7000.
Weekly Fundamental Forecast for Australian Dollar
The Australian dollar has several advantages, yet victory is slipping away. The Reserve Bank continues to discuss raising interest rates, the S&P 500 recently hit a record close, and seasonal factors point to an imminent strengthening of the Chinese yuan, for which the aussie serves as a proxy currency. Nevertheless, the AUD/USD is in no hurry to rise. If the market is not moving in the expected direction, it is likely to move in the opposite one.
The Reserve Bank of Australia kept its key interest rate at 4.35% at its August 11 meeting. RBA Governor Michele Bullock noted that monetary policy had been tightened three times since the start of the year and that the RBA would do so again if necessary. Financial conditions have tightened, and the economy is slowing slightly, as expected following a 75-basis-point increase in borrowing costs. However, inflation remains high.
On paper, this hawkish stance should have supported AUD/USD quotes, given that Australian bonds responded to Michele Bullock’s speech with rising yields. At the same time, the futures market continues to price in a 60% probability of a 25-basis-point cash rate hike by December. However, in reality, the aussie has been unable to capitalize on the door left open to further monetary tightening.
Central Banks’ Interest Rates
Source: Bloomberg.
The Reserve Bank’s interest rate is higher than that of many other central banks, making the Australian dollar a yield-seeking currency that, in theory, should be sensitive to shifts in global risk appetite. Against this backdrop, the S&P 500 rally has long supported the AUD/USD. However, the stock market’s rise may contain the seeds of its own reversal.
The S&P 500’s gains are being driven primarily by strong corporate earnings. At the same time, we have reached a point where robust earnings are pushing Treasury yields higher. According to Kevin Warsh, this is tantamount to a tightening of monetary policy. In fact, the logic is straightforward: strong corporate results signal resilient domestic demand, which in turn can add to inflationary pressures.
S&P 500 Companies’ EPS and 10-Year Treasury Yield
Source: Bloomberg.
In essence, the stock market is walking on red-hot coals: the stronger corporate earnings are, the greater the likelihood of monetary tightening, which would be a bearish factor for the S&P 500. The Australian dollar is facing the same dilemma.
The AUD/USD pair is showing little reaction to the yuan’s bullish outlook. The completion of dividend payments to foreign holders of Chinese stocks at the end of August, combined with rising exports, suggests that the USD/CNH may decline.
Weekly AUDUSD Trading Plan
The fact that the aussie is not rallying despite having several significant strengths masks its underlying vulnerability. At the same time, accelerating US inflation could provide an opportunity to sell the AUD/USD with a target at 0.7000.
This forecast is based on the analysis of fundamental factors, including official statements from financial institutions and regulators, various geopolitical and economic developments, and statistical data. Historical market data are also considered.
Price chart of AUDUSD in real time mode
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