The Australian and New Zealand Dollars finished higher after reversing earlier weakness last week. The price action does not reflect a shift in central bank policy by the Reserve Bank of Australia (RBA) and the Reserve Bank of New Zealand (RBNZ), but rather position-squaring in response to weaker-than-expected U.S. economic data that could be signaling a U.S. Federal Reserve rate cut later in the year.
The Aussie and Kiwi were trading steadily lower last week until Thursday when both currencies surged to the upside on aggressive short-covering following the release of weaker than expected U.S. economic data. The news drove U.S. Treasury yields to multi-year lows as investors increased bets on a Fed rate hike.
The drop in Treasury yields helped tighten the spread between U.S. Government bond yields and Australian and New Zealand Government bond yields, making the U.S. Dollar a less attractive investment.
At mid-week, the Fed released the minutes from its May 1-2 monetary policy meeting. The minutes offered no surprises and the Aussie and Kiwi showed a muted reaction to the news. The Fed basically said to be “patient” because rates are likely to stay where they are for “some time”.
However, on Thursday, May 23, investor sentiment changed when the U.S. released weaker-than-expected Flash Manufacturing and Services PMI data. The news raised concerns over the impact of the U.S.-China trade dispute on the U.S. economy, driving U.S. Treasury yields sharply lower as investors increased bets on a U.S. Federal Reserve rate cut later in the year.
Fed Fund futures are currently pricing in 50% chance of a cut in September and a full 25 basis-point cut by December. Traders are also looking for another rate cut for next year. As the trade war drags on the data-dependent Fed will have an easy choice in cutting rates. To some the question is not will they deliver a shift, but when.
The above statement is driving the price action at this time, and encouraging Aussie and Kiwi short-sellers to aggressively cover their positions. Traders should note that the reversals to the upside are being fueled by position-squaring and short-covering, and not a change in policy by the RBA and RBNZ. Therefore, the rally is likely to be short-lived and likely to last until investors make the necessary adjustments to the possibility of a Fed rate hike.
This is a holiday-shortened week in the U.S. because of Monday’s Memorial Day holiday. The major report in the U.S. will be Thursday’s preliminary GDP report. It is expected to come in at 3.1%, slightly below the 3.2% previously reported.
Traders will also get the opportunity to react to the RBNZ Financial Stability report and a speech by RBNZ Governor Orr early Wednesday. Early Thursday, look for a reaction to the Annual Budget.
In Australia, the focus will be on Thursday’s Buildings Approvals and Private Capital Expenditure reports.
I don’t think the events in New Zealand and Australia will have too much of an impact on the AUD/USD and NZD/USD with traders primarily focused on the U.S. economy at this time. Therefore, look for greater reactions to the U.S. data especially to reports that deal with future growth.
Weaker-than-expected U.S. data will likely exert the greatest upside pressure on the Aussie and Kiwi.
This article was originally posted on FX Empire
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