When a currency ignores the negatives and rises sharply on the positives, there is a sense that it is ready to break the downward trend. Good news from the Australian labor market, rumors that the Reserve Bank will continue the monetary restriction cycle, support from iron ore, and stability of the Chinese yuan allowed AUD/USD to soar above 0.67. Meanwhile, the pair grew faster after the Fed's May meeting and U.S. inflation statistics than it fell on American employment. Is it really ready to change the trend?
Record low Australian unemployment rates, the first local budget surplus since 2008, and an unexpected resumption of a cash rate increase in May after a pause in April breathed new life into the "Aussie." According to materials presented for Bloomberg, the RBA considered options for increasing borrowing costs to 4.8%, significantly higher than the current 3.85%. In two out of three scenarios, such a high level of cash rate was foreseen to return excessively high inflation to target. This would make the Reserve Bank almost the leading "hawk" among the G10 currency issuers.
Dynamics of Central Banks' base rates
However, it is unlikely that Reserve Bank Governor Philip Lowe and his colleagues are ready to go that far. Inflation is starting to slow down. This is a global trend. The Fed is ready to stop monetary restriction, fearing a recession. The RBA faces the specific risk of breaking something. In my opinion, May's cash rate hike is the penultimate, if not the last. The market is overestimating the Reserve Bank's capabilities.
The same can be said regarding China's economy, Australia's main trading partner. Investors believed that its rapid recovery after COVID-19 would become a catalyst for strengthening the yuan and related proxy currencies. However, the stability of USD/CNY is deceptive. It is more related to the weakening of the U.S. dollar than to the strength of the yuan. The trade-weighted exchange rate of the Chinese currency continues to decline. This indicates an overestimation of the potential for recovery of the Chinese economy.
Dynamics of the trade-weighted yuan index
The rebound of iron ore, a key component of Australian exports, from its lowest level since the start of 2022, should be viewed with a degree of skepticism. Yes, in April, the import of this raw material increased by 5% to 90.44 million tons, but the "bearish" trend remains in force. And this creates headwinds for the "Aussie."
Thus, the Australian dollar's trump cards are not as strong as they seem. Meanwhile, its American counterpart is gradually spreading its wings due to the Fed's firm intention to keep the federal funds rate at a plateau, at least until the end of the year. The market did not believe this and paid the price.
Technically, a Broadening Wedge pattern formed on the AUD/USD daily chart. The formation of rising highs and lows speaks of a fierce battle between "bulls" and "bears." Although, it seems that the sellers are winning. The pair's inability to return above 0.6755 is a reason to open shorts.