Fed Rate Hike Bets Leave Nikkei 225 at Risk, AUD/USD Eyes New Low?

2018-10-03 23:00:00

Daniel Dubrovsky, Contributing Senior Strategist

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Asia Pacific Market Open – Italian Budget, US Bond Yields, US Dollar, ISM Services, Jerome Powell
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Asia Pacific Market Open – Italian Budget, US Bond Yields, US Dollar, ISM Services, Jerome Powell

Uplifting Italian budget news began Fed rate hike bets as the US Dollar broadly soared
ISM services data and Fed Chair Jerome Powell speech further lifted Treasury yields
Emerging markets were left vulnerable as tightening global credit conditions bodes ill
Ahead, Asia Pacific shares may decline which may send AUD/USD to a new 2018 low

We just released our 4Q forecast for the US Dollar in the DailyFX Trading Guides page

What began on Wednesday with market optimism as Italy took a step towards reducing a potential budget conflict with the EU ended up transpiring throughout the entire session. This seemed to have increased the chances that the Fed could proceed with tighter monetary policy as EU instability risk was reduced, offering the US Dollar broad gains as local government bond yields rose.

The 10-year and 30-year yield touched their highest since 2011 and 2014 respectfully, offering a reversal in the S&P 500 which left it little changed by market close. Increasing returns from haven assets, of which US Treasuries are a benchmark for, reduces the appeal of stocks. The latter are also dampened by hawkish monetary policy bets. It speaks to the central bank’s actions to tame growth before inflation gets out of hand.

US economic data outperforming also fuels this trading dynamic which was indeed the case Wednesday. A record breaking ISM services sector outcome added more gains to the US Dollar. This was then followed with the cherry on top, bold commentary from Fed Chair Jerome Powell towards the end of the session. He said that the central bank, in its tightening path, could go beyond a neutral level of rates.

Additional Commentary From Fed Chair Jerome Powell

I am very happy about where the economy is, inflation is right at our 2% goal
We are gradually raising rates to ensure that inflation stays tame
The Phillips curve is not dead but may be resting
Expect to continue to see a gradual increase in wages, we are a long way from neutral rates

Other relatively high-yielding FX major currencies lost ground against the greenback, the Australian and New Zealand Dollars depreciated broadly. Meanwhile emerging markets suffered as well. The MSCI Emerging Markets ETF, which did gap higher, declined over 1.5% from its open. This is not too surprising as tightening global credit conditions will continue pressuring developing nations with large external debts.

During Thursday’s Asia Pacific trading session, we may see local benchmark stock indexes echo concerns about tightening global borrowing costs. This would continue pressuring AUD and NZD lower while perhaps offering some gains to the anti-risk Japanese Yen. Meanwhile the Australian Dollar awaits the next round of trade balance which carries implications for GDP, but may not offer much for RBA policy bets.

AUD/USD Technical Analysis

Yesterday, we outlined an AUD/USD short trade setup which required prices to rise to 0.71998 for an optimal entry point. Unfortunately, the pair’s impressive downside performance left this order unfilled and as a result has invalidated the setup. We remain bearish AUD/USD but prices are too close to support to justify an immediate new short.

With that in mind, we will be closely watching how the Australian Dollar behaves around 0.70852. If the pair closes under this support area, this may open the door to a new AUD/USD short. Meanwhile near-term resistance is the December/May 2016 lows between 0.71452 and 0.71600. You may follow me on twitter @ddubrovskyFX for updates on the trade.