Aussie to Build on Rally as Yen Reverses if ISM Surprises Higher

The Australian Dollar is likely to extend higher as the Japanese Yen reverses lower if the ISM gauge of US service-sector activity surprises to the upside.

Talking Points

• Australian Dollar Gains as RBA Pours Cold Water on Rate Cut Outlook
• Japanese Yen Follows 10yr JGB Yields Higher on Bond Sale Demand Drop
• Upside Surprise on USNon-Mfg ISM May Drive Swell in Risk Appetite

The Australian Dollar pushed higher in overnight trade after the Reserve Bank of Australia (RBA) opted to keep the benchmark interest rate at 3 percent as expected and poured cold water on future easing. RBA Governor Glenn Stevens said that while the outlook for economic growth suggested “an accommodative stance of monetary policy is appropriate [the] substantial easing of policy as a result of previous decisions [suggested] it was prudent to leave the cash rate unchanged.” The message is an increasingly familiar one, arguing the central bank feels it has already offered enough accommodation and now wishes to see it filter into the real economy before moving forward with further easing.

The Japanese Yen advanced as yields on the benchmark 10-year government bonds pushed sharply higher, adding 2.6 percent to record the largest daily advance in over two weeks. The move followed a poor showing at an auction of 10-year notes, where the bid-to-cover measure of demand fell to 2.37 compared with 2.75 at a sale of similar paper a month ago, marking the weakest uptake since July 2009. The surge in borrowing costs appears to have eroded the Yen’s near-term appeal as a cheap funding vehicle, forcing an unwinding of carry trades financed in the perennially low-yielding currency.

All eyes are now on the US ISM Non-Manufacturing Composite gauge, with expectations pointing to a slight slowing in service-sector activity growth. Economists are penciling a reading at 55.0 in February compared with 55.2 in the prior month. A print in line with forecasts would fall firmly in line with near- to medium-term trend averages. US economic data has markedly improved relative to expectations since early February however, leaving the door open for an upside surprise if this momentum continues to carry forward.

Such an outcome may boost hopes for the resilience of recovery in the world’s largest economy in the face of strengthening fiscal headwinds following the triggering of “sequester” spending cuts last week. That may boost risk sentiment, re-applying downward pressure on the Yen as traders’ appetite reboots carry demand. The removal of the specter of rate cuts may likewise allow the Australian Dollar to advance in a risk-on environment as traders flock to the highest yields in the G10 FX space.

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--- Written by Ilya Spivak, Currency Strategist for Dailyfx.com

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