Australian Dollar Outlook: AUD/USD Divergence With Wall Street Risks Continuing

Australian Dollar Fundamental Forecast: Neutral

• Australian Dollar may struggle to capitalize on rosy market mood
• Falling inflation bets and local bond yields sapping AUD’s appeal
• Focus on the Fed’s tapering outlook and RBA meeting minutes next

All things considered, it has been pretty quiet for the sentiment-linked Australian Dollar. AUD/USD one-week implied volatility continues to aim lower from late February peaks. The currency continues to trade broadly sideways against its major peers, but with a very slight downside bias since finding a top earlier this year. This is despite market mood remaining fairly stable and upbeat, something that tends to benefit AUD.

So, what gives and will this trend continue? Monetary policy expectations are likely playing a key role here. The decline in longer-term Treasury yields is not just isolated to the United States, but it has been spilling over to Australia. The local 10-year rate aimed for the worst weekly performance in about one year as Australian inflation expectations eased.

This was in the aftermath of this month’s RBA rate decision, where the central bank further cooled hopes of sooner-than-anticipated policy tapering. This is likely weighing against the Australian Dollar, preventing it from capitalizing on the rise in the S&P 500 and progress in Chinese equities. Due to Australia’s key trading relationship with China, market sentiment from the latter can make its way into the latter.

With that in mind, this environment is likely shaping up for another quiet reaction to Australia’s next jobs report on Thursday local time. More focus may be given to the RBA meeting minutes, where the Aussie is likely vulnerable to further dovish commentary. The Aussie will also be tuning in for a speech from the central bank’s governor, Philip Lowe, hours before the jobs report.

Arguably, the most important event risk will likely come from the United States. The Federal Reserve will be hosting its next monetary policy announcement. Markets will be focusing on updated interest rate projections, and Chair Jerome Powell will almost surely be asked about where the Fed stands on tapering policy. Reiterating that inflation is transitory, especially amidst May’s high CPI report, may keep sentiment stable.

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Australian Dollar Index Versus Wall Street and AU 10-Year Government Bond Yield

Chart Created Using TradingView

--- Written by Daniel Dubrovsky, Strategist for DailyFX.com

To contact Daniel, use the comments section below or ddubrovskyFX on Twitter