Will Aussie Dollar Strength Prevail in 2018?

The Aussie dollar experienced strength throughout 2017 against its US counterpart with a strong rally to finish the year before forming a double top last week. Over the past week, AUD/USD has fallen almost 2%, following a CPI miss in Australia and a positive earnings report in the United States. Is this a sign of things to come for the remainder of 2018 or will Aussie dollar strength prevail?

Throughout 2017, one of the main concerns of the Reserve Bank of Australia was AUD strength that resulted from a rally in metal prices and US dollar weakness. As Australia is a net exporter, a weaker currency is favored and with current rates at 1.5%, some analysts feel that it is unlikely for the RBA to raise rates this year. Westpac have also said that they do not see any rate hikes in the near future. However, recent data is showing that the economy is strengthening along with other countries globally which is expected to lead to inflationary pressure. In order to keep up with the global economy, this could result in the possibility of a rate hike later this year. Many asset managers currently have a negative outlook on the Australian dollar as they believe that AUD/USD has risen on US dollar weakness rather than Aussie dollar strength. A key event for this pair will be the upcoming monetary policy statement from the RBA where analysts are expecting a more hawkish tone.

The US dollar, on the other hand, is not having the best of runs despite a strengthening economy. The rate statement released by the Fed earlier this week increased the odds of a March rate hike, with a total of three hikes expected for the year. There is also the possibility of a fourth hike if data continues to improve and inflation begins to catch up with the rest of the economy. In addition, we saw a positive earnings report with NFP and average earnings beating expectations, allowing a strong finish on Friday for the dollar. Bond yields increased throughout the week, with the 10-year treasury yield, in particular, heading towards 3% which investors consider a significant level. This was based on the global economy starting to rise, increasing expectations of inflationary pressure. However, the dollar continues to struggle against many other currencies with the dollar index seeing only a small gain last week and weakness is expected to continue in the coming weeks. A large part of this is down to the eurozone economy, where we saw GDP growth that was larger than that in the US and UK. Analysts are now anticipating that the ECB will unwind its quantitative easing program and tighten monetary policy at a quicker pace than previously expected. Central banks globally are expected to follow on and also begin tightening policies, which should see them catch up with the US.

Based on the current fundamentals, the weakness of AUD/USD seems to simply be a retracement and we should see a bullish run up until March. In March, we will assess the stance of the RBA against the Fed. If the RBA look to hold rates for the majority of the year and the Fed continue hiking, we will get a policy pergence with the Fed rate exceeding the RBA rate, at which point, AUD/USD weakness should kick in. Over the short term, we will be looking for buying opportunities on this pair and from Q2 we could be looking at short positions with long term targets around 0.75. However, traders should keep in mind that the fundamentals and sentiment can change quickly so it is important to frequently reassess long term positions. A prime example of this is the EUR/USD currency pair which completely went against analyst expectations in 2017.

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