The Australian dollar’s rally stalled overnight on the back of the release of the US Fed Reserve’s minutes.
“The Aussie was trying to rally toward the .76 cents level until it met resistance,” said Greg McKenna, chief market strategist at CFD and FX provider AxiTrader.
“The Fed minutes revealed the notion of the Fed tapering its balance sheet is already being discussed. And this hurts stocks which in turn hurt the Aussie as a risk asset,” McKenna said.
The Aussie dollar is trading around the 0.7567 level this morning.
According to McKenna, the question in people’s mind now is if the Fed is signalling both caution on stocks and that it will likely begin to taper its balance sheet this year, “Is the whole reflation trade overdone and what impact will that have on the Australian dollar?”
From his perspective, McKenna said that’s a reasonable question because the Aussie dollar and drivers like commodity prices, and interest rate differentials are a big part of this reflation play.
“And if there is a risk that markets have gotten ahead of themselves and valuations are stretched – as the Fed suggests – then the risk is the Australian dollar has further downside,”
But it’s a risk right now because forex markets were remarkably sanguine – along with bonds – to the Fed’s warning.
Naturally, that is because the US Fed was careful to include words in the minutes which expressly ruled out roiling markets.
The Fed said it wants to move toward balance sheet normalisation in a manner that is seen as “reducing the risks of triggering financial market volatility or of potentially sending misleading signals about the Committee’s policy intentions.”
Longer term though the minutes reinforce that if the US economy continues on the current track, the Fed will be raising short end rates over the course of 2017 and 2018.
But it will also stop reinvesting interest, and likely principal, into the bond market at some point in that time frame.
“That should put upward pressure on interest rate differentials and the US dollar. That will weigh on the Aussie,” McKenna said.
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