Fundamental Forecast for the Australian Dollar: Neutral

  • Conflicting cues abound as markets eye CPI data to inform RBA views
  • Hawkish FOMC statement may renew risk aversion, sink Aussie Dollar
  • See how FXCM traders are positioned in AUD/USD with DailyFX SSI

The Australian Dollar launched an aggressive recovery last week, posting the largest five-day advance in three months against a backdrop of firming risk appetite. Follow-through is far from assured however as a busy docket of high-profile event risk promises volatility and threatens to cap upside momentum.

On the domestic front, the fourth-quarter CPI report is in the spotlight. Economists’ expectations point to an uptick, with the benchmark inflation rate rising to a one-year high of 1.6 percent. Australian economic news-flow has increasingly outperformed relative to consensus forecasts over recent months, suggesting analysts’ models may be underestimating the economy’s vigor and opening the door for an upside surprise. Leading survey data paints a worrisome picture however, suggesting price growth waned in late 2015.

A soft CPI result is likely to bolster RBA interest rate cut expectations, pushing the Aussie Dollar broadly lower. Needless to say, a higher print stands to deliver to the opposite dynamic as traders scale back bets on near-term stimulus expansion.

Turning to external catalysts, a monetary policy announcement from the US Federal Reserve takes top billing. Chair Janet Yellen and company are widely expected to maintain the status quo this time around, with Fed Funds futures assigning a mere 11.9 percent chance of another rate hike. Markets will pay very close attention to the tone of the statement accompanying the rate decision however as traders attempt to gauge the degree to which recent risk aversion has undermined officials’ appetite for tightening.

The rout in risky assets has noticeably undermined investors’ views on the amount of stimulus withdrawal to be done in 2016. Indeed, a gauge of the priced-in year-end rate hike path derived from futures pricing has slumped alongside the S&P 500 since the beginning of the year. This suggests that investors expect the Fed to scale back rate hike intentions following recent turmoil.

With that in mind, measures tracking progress on the Fed’s dual employment- and inflation-oriented mandate have largely improved. Core inflation and the pace of wage growth have firmed and payrolls growth has proven more robust than economists expected. For its part, the central bank has said that communicating its intentions to the markets remains a key challenge, hinting that it intends to stick with its December projection of four rate hikes in 2016 despite the dovish shift in investors’ outlook (which now calls for just one 25bps increase this year).

January’s FOMC policy statement offers officials an opportunity to signal that financial market angst alone will not be enough to derail their game-plan as long as progress on the mandate continues to be made. Risk appetite is likely to sour if they choose to take it, sending the Aussie lower alongside stock prices.