Australian Dollar Still Vulnerable But Reversal Risk Mounting

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Forex_Australian_Dollar_Still_Vulenrable_But_Reversal_Risk_Mounting_body_Picture_5.png, Australian Dollar Still Vulnerable But Reversal Risk Mounting

Fundamental Forecast for Australian Dollar: Neutral

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The Australian Dollar found itself under pressure once again last week as shifting monetary policy expectations continued to undermine demand for the high-yielder. The sharp swoon in the AUDUSD exchange rate since the beginning of May has been accompanied by a brisk narrowing of the yield spread between benchmark US and Australian 10-year bond yields. This implies an Aussie-negative realignment of investors’ perceptions of relative returns to be had from holding one currency over the other. That spread ended last week at 1.0892 percent, a hair above the record low at 1.0711 percent recorded in November 2008 at the height of the global financial crisis.

The week ahead brings another round of top-tier fundamental event risk to inform policy expectations.On the Australian side of the equation, the spotlight will be on the Employment report. Expectations suggest the economy lost a net 10,000 jobs in May while the unemployment rate reversed April’s improvement, returning to the 40-month high set in March at 5.6 percent. The outcome may reinforce bets on a July interest rate cut from the RBA, which traders now price in with a 55 percent probability according to data from Credit Suisse. This would encourage continued narrowing of the yield spread, weighing on the Aussie.

Meanwhile in the US, the central topic of conversation remains the likelihood and timing of a reduction in the Federal Reserve’s monthly asset purchases. The US Dollar rose on Friday after a slightly larger than forecast increase in nonfarm payrolls in May was countervailed by a downward revision to the April reading, yielding an outcome broadly in-line with expectations on net. Traders that feared an upside surprise might hasten the Fed’s hand cheered on the result, with a swell in risk appetite pulling Treasury yields higher and offering support to the greenback.

In the coming days, the May Retail Sales report and June’s preliminary University of Michigan Consumer Confidence figure take top billing. Results in line or worse than expected may further distance the threat of a reduction in Fed support in the mind of investors, boosting sentiment and sending US bond yields upward. That would help further shrink the spread between the relative return on US and Australian Dollars in favor of the greenback, lending a hand to AUD/USD sellers. Needless to say, stronger results promise the opposite results.

Perhaps most critically, the market has become intensely data-dependent, making for a volatile environment. Furthermore, while a swell in futures volumes suggest the recent selloff is underpinned by strong commitment, Australian Dollar net-short positioning is now at a record high. This warns makes for a market vulnerable to aggressive profit-taking if news-flow offers even a somewhat lackluster catalyst.

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