Australian Dollar Scales 1-week High on Reboot of Dovish Fed Bets

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The Australian Dollar reached a one-week high following improved investor sentiment that followed a reboot in expectations for an outsized 50 basis point interest rate cut from the Federal Reserve.

"AUD/USD scales one–week peak on 50 bps Fed rate cut risk," says Robert Howard, a Reuters market analyst. "Ascent to 0.6733 spurred by higher risk of 50 bps Fed rate cut next week."

The Australian Dollar is one of the most highly sensitive of the G10 currencies to shifts in global sentiment, tending to outperform its peers when commodity prices and stock markets rise. Markets have put in a decent recovery following a midweek swoon, and this is bolstering Aussie Dollar exchange rates.

The Pound to Australian Dollar exchange rate fell back to 1.95 through the Thursday session, but we note Sterling is also doing well in this improved market mood, which is limiting downside. Instead, AUD outperformance is best expressed via the AUD/USD conversion, which is at 0.6720 after rising a chunky 0.75% over the past 24 hours.

Shifting expectations ahead of next week's crucial Federal Reserve policy update are behind currency movements, with markets currently seeing a 43% chance of a 50 bps cut on Sept 18, whereas the chance of 50 bps cut next week was only 13% after U.S. CPI data Wednesday.

Howard says there is now a higher risk of a half-point Fed cut due to reports in the Wall Street Journal and the Financial Times. Also cited was a speech by a former member of the Federal Reserve's interest rate setting committee, the FOMC.

Former Federal Reserve policymaker Bill Dudley made it clear he would push for a 50 basis point interest rate cut were he still in the FOMC.

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"I think there's a strong case for 50, whether they're going to do it or not," he said at the Bretton Woods Committee's annual Future of Finance Forum in Singapore.

But how does a former member of the FOMC still hold such sway over the market?

Francesco Pesole, FX Strategist at ING Bank, says the following part of Dudley's speech was particularly important: "It's very unusual to go into the meeting with this level of uncertainty – usually the Fed doesn’t like to surprise markets".

Pesole explains that one possible interpretation is that markets themselves can tilt the balance towards a half-point move should their dovish bets be pent up into Wednesday’s meeting.

"There were also some media reports suggesting it would be a close call between 25bp and 50bp, which contributed to the dovish repricing," he says.

The FT meanwhile leads on Friday with a report that states, "the Federal Reserve faces a close call on whether to cut US interest rates by a larger than expected half-point next week or go with a quarter-point move as officials wrestle with how quickly to ease monetary policy."

The Wall Street Journal's much-respected Fed specialist, Nick Timiraos says the Fed still faces a dilemma to "start big or small". Derek Halpenny, Head of Research for Global Markets EMEA at MUFG Bank Ltd says this article is "being interpreted by the markets as being an orchestrated move by the Fed given this journalist is known to have Fed links."

Also in the AUD's corner is the recovery in commodity prices, with the Bloomberg Commodity Index is heading for a strong weekly rebound, up around 2.5%, with all sectors showing gains.

Gold reached a fresh record high around USD 2,570 in Asia today as it continued to build on yesterday’s breakout above USD 2,530. Crude prices continued a rebound from a three-year low, despite the IEA warning that global oil demand growth is slowing sharply due to China’s cooling economy.