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Australian Dollar May Drop as Fed Rate Hike Sinks Risk Appetite

Australian Dollar May Drop as Fed Rate Hike Sinks Risk Appetite

2015-12-12 01:43:00
Ilya Spivak, Sr. Currency Strategist
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Australian Dollar May Drop as Fed Rate Hike Sinks Risk AppetiteAustralian Dollar May Drop as Fed Rate Hike Sinks Risk Appetite

Fundamental Forecast for the Australian Dollar: Bearish

  • Australian Dollar Looks to Fed Policy Announcement for Guidance
  • Risk Aversion After FOMC Rate Hike May Drive Aussie Downward
  • Find Key Turning Points for the Australian Dollar with DailyFX SSI

The Federal Reserve monetary policy announcement is firmly in focus for the Australian Dollar in the week ahead. Chair Janet Yellen and company are widely expected to deliver the first post-QE interest rate hike, nudging the target range for the benchmark lending rate higher by 25 basis points into the 0.25-0.50 percent territory.

Fed Funds futures assign the outcome a priced-in probability of 81 percent. Market consensus appears tilted toward a “dovish hike”, meaning the increase is expected to be coupled with painstakingly cautious rhetoric signaling that the on-coming tightening cycle will be shallow and slow-moving.

Currency markets have been busy pricing in the Fed’s move toward the hawkish side of the policy spectrum since mid-2014, after it became clear that a growth dip in the first few months of tapering QE asset purchases will not derail the process. The US Dollar surged, adding over 16 percent since then and through this year against its leading counterparts.

A similar adjustment seems to have been absent on the risk sentiment front. The Fed’s aggressive easing over the past seven years slashed returns on safer assets and encouraged a reach for yield outward along the risk spectrum. Fears of on-coming stimulus withdrawal might have been expected to begin reversing this dynamic, but various false starts failed gain traction.

This warns that a period of portfolio readjustment is still pending and may be triggered in earnest once the rate hike is finally a reality. The ensuing risk aversion is likely to bode ill for the sentiment-linked Australian Dollar, sending the currency downward alongside stock prices. Indeed, the S&P 500 – a proxy for global risk trends – may be pre-positioning already having finished last week with the largest daily drop in over two months.

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