Forex_Australian_Dollar_Recovery_Faces_Evolving_Fed_QE_Speculation_body_Picture_5.png, Australian Dollar Recovery Faces Evolving Fed QE Speculation

Fundamental Forecast for Australian Dollar: Bullish

  • Chinese Economic Data to Remain a Source of Aussie Support as HSBC PMI Ticks Higher
  • Busy US Data Docket, Fed-Speak Schedule Threaten Aussie as QE3 Taper Views Evolve
  • Shift in DailyFX SSI Marks Australian Dollar Bottom, Beginning of an Upward Reversal

We’ve argued in favor of a significant Australian Dollar recovery since early August. We noted that an improvement in Chinese news-flow will probably help arrest the slide in economic growth expectations for the East Asian giant. China is Australia’s largest trading partner and a critical source of demand for the country’s pivotal mining sector. That meant that stabilization in China was likely to translate into an improved the outlook for Australian exports and the business cycle overall. This in turn would prompt a supportive shift in RBA monetary policy expectations and lay the groundwork for an Aussie recovery. The case for an upside scenario seemed all the more compelling against a backdrop of highly over-extended speculative net-short positioning and we proceeded to enter long AUD/USD after an attractive technical setup presented itself.

The recovery has started to gain momentum as expected, with the latest positioning data pointing to aggressive short-covering. The week ahead brings relatively little on the Australian domestic front to upset this dynamic. The flash estimate of September’s HSBC Chinese Manufacturing PMI measure amounts to the only bit of economic data risk. Consensus forecasts call for continued acceleration in factory-growth after the index hit a 16-month high in August, reinforcing the virtuous influence of Chinese news-flow on RBA policy bets and the Aussie. Indeed, priced-in interest rate cut expectations have steadily improved over the past six weeks and no longer signal any further easing over the coming 12 months (according to data compiled by Credit Suisse).

The risk of an adverse shock from macro-level forces remains significant however. Last week, the Federal Reserve hit the reset button on investors’ baseline outlook for the evolution of the QE3 program, unexpectedly opting not to taper the size of monthly asset purchases. The markets seemed to have become borderline complacent about the prospect of a September cutback over recent weeks but data-driven volatility now looks likely to return as the new status quo is thrashed out. That points the spotlight to the US economic calendar, where a packed docket headlined by Consumer Confidence, Durable Goods and Home Sales reports offers plenty of fodder for speculation.

The “Fed-speak” roster is likewise crammed, with six of the 11 current members of the FOMC committee due to deliver commentary. Needless to say, that elevates the possibility that an external shock that derails the Aussie’s advance may emerge. Perhaps the most hawkish message that could be relayed by policymakers is that the timeline to wind down QE3 continues to envision an end-point in the middle of next year. That would imply that given the later-than-expected start of the tapering process, future reductions will have to be necessarily larger, making for an accelerated removal of stimulus. Such a scenario is likely to drive risk aversion across financial markets, pulling the Australian unit lower along the way.