Australian Dollar Strength to be Limited

An impressive rise in AUD/USD at the start of the new month appears to have stalled but we note there is further room to climb before it reaches a key barrier.

A strong start to the new month for the Australian Dollar saw the currency leap 0.88% against the US Dollar on the observation that Trump is catching Clinton in the polls.

A bout of Dollar selling reflects that markets believe a Trump victory to be potentially disruptive to the status quo.

However, the AUD also strengthened across the board after the RBA decided to keep rates at 1.5% on strong labour market data, mixed inflation data and iron ore prices being at a six-month high.

The decision was broadly anticipated by market participants, however, the market was not expecting such a statement to come from Philip Lowe.

"The RBA Governor seems ready to keep inflation below the 2% to 3% target band in order to avoid putting pressure on an overheating real estate market. Moreover, the strong job market and solid growth figure mean there is no urgent need to provide more stimulus," says Yann Quelenn at Swissquote Bank.

AUDUSD rose after the rate decision, however Quelenn remains nonetheless bearish on the pair as demand for USD will increase

The Aussie has found it increasingly difficult to rise above 0.77 highs despite four attempts over recent months.

The lack of upside for the pair comes despite recent data showing the Australian economy is performing well.

The apparent explanation for this lack of upside comes from increasingly firm expectations that US Federal Reserve will increase interest rates in December 2015.

Robust Australian Fundamentals

Westpac Bank’s FX Strategist Sean Callow sees the lack of upside as something of a mystery given the Aussie has such positive fundamentals backing it.

“The Aussie dollar has received plenty of positive news this week.

“Most eye-catching has been a further lurch higher in key commodity prices, which had already made strong gains since June,” said Callow.

Iron Ore, Australia’s largest export has risen by 10% in the last week, whilst Coking Coal, which is used in the manufacture of steel has risen by 148% since August.

“This points to a substantial further narrowing of Australia’s trade deficits in the months ahead, an acceleration in nominal GDP growth and improvement in both the federal and state budget positions.

“All this should be bullish for AUD,” concluded Callow.

The new governor of Reserve Bank of Australia (RBA), Philip Lowe also helped the Aussie recently by making it clear in his inaugural speech to parliament that he did not have any plans to cut interest rates anytime soon.

Last week’s significant inflation data showed an unexpected rise in prices which further supported the Aussie as it made it even less likely the RBA would cut interest rates again.

“Inflation remains the key release for the RBA and this week’s Q3 data was another source of fuel for the Aussie.

“Indeed, the sharpest rise in AUD/USD this week was in response to the above-consensus reading on headline inflation, up from just 1.0% y/y in Q2 (a low since 1999) to 1.3% y/y,” said Callow.

Carry Considerations

Higher interest rates mean the Aussie already benefits from decent inflows from the carry trade in which investors sell a low yielding currency for a higher yielding counterpart.

The Australian currency is popular amongst carry traders due to the RBA’s base interest rate of 1.5%, which is relatively high.

Supportive inflows from ‘carry’ mean the Aussie is always in a strong position by default.

Heavy US data could push USD higher

The US Dollar is likely to exhibit substantial volatility this week as the calendar is veritably crammed with event risk, from ISM Manufacturing, to the Fed policy meeting, to Non-Farm Payrolls.

Westpac’s Franulovich says that with such a busy calendar and an expectation that data is going to follow the recent broad trend in data higher, the risks are tilted to the dollar rising.

“Toppish USD (Dollar Index) price action in front of the key 100 level raises some doubts about the uptrend but a heavy slate of event risk next week – both ISM surveys, payrolls and an FOMC meeting - should tip the scales in favour of at least one more clear leg-up for the USD,” said Franulovich in a recent note.

Given the risk of a continuation higher for the dollar it seems as yet unlikely that AUD/USD will be able to make a clear break above 0.77 with ease, and further gains would be dependent on the quality of US data.