USD Rally Overbought, Aussie Outlook Weighed By Rate Cut Expectations

DJ FXCM Dollar Index

The Dow Jones-FXCM U.S. Dollar Index (Ticker: USDollar) is 0.87 percent higher from the open after moving 78 percent of its average true range, but we may see a correction unfold over the next 24-hours of trading as the greenback remains overbought. As the 30-minute relative strength index falls back from a high of 81, the rally to 9,936 may have been a false breakout, and the USD may consolidate back within the upward trending channel as we expect market participation to thin ahead of the holiday weekend. In turn, the index fall back towards the lower Bollinger Band around 1.,862 before we see another move to the upside, but we may see a large rebound in risk sentiment as the economic docket for this week is expected to instill an improved outlook for future growth.

As the USD appears to be finding resistance at the 61.8 percent Fibonacci retracement around 9,947, we should see the greenback consolidate in the days ahead, and an upward revision in the preliminary 3Q GDP report could spark a rebound in risk appetite as the development raises the outlook for the world’s largest economy. Indeed, the growth rate is expected to expand at an annual rate of 2.5 percent, but the recent developments coming out of the U.S. could pave the way for an above-forecast print as Fed officials see economic activity gathering pace. Should the development instill a positive outlook for future growth, expectations for a more robust recovery could fuel a rise in risk appetite, and we may see market participants move away from the reserve currency as they look for greater returns. In turn, the USD may fall back towards the 50.0 percent Fib around 9,828 to test for near-term support, but we may see the greenback gain ground over the remainder of the year as the outlook for 2012 remains clouded with high uncertainty.

All four components weakened against the greenback, led by a 1.93 percent decline in the Australian dollar, and the high-yielding currency may give back the rebound from 0.9390 as risk sentiment falters. Nevertheless, market participants are still looking for a 25bp rate cut in December as the isle-nation faces a slowing recovery, and the AUD/USD may face additional headwinds in 2012 as investors see the Reserve Bank of Australia carrying its easing cycle into the following year. According to Credit Suisse overnight index swaps, market participants see the benchmark interest rate being lowering by more than 150bp over the next 12-months, and speculation for lower borrowing costs is likely to exacerbate the bearish underling the high-yielding currency should the central bank continue to cast a dovish outlook for monetary policy. As the AUD/USD slips back below the 38.2% Fib from the 2010 low to the 2011 high around 0.9920-50, we may see the exchange rate make a run at the 50.0% Fib around 0.9570-0.9600, and the aussie-dollar may trend lower in the following year as it carves out a double-top in the second-half of 2011.

--- Written by David Song, Currency Analyst

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