Australian Dollar Steadies but Fed's Big Test, U.S.-China Dialogue Loom 

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The Australian Dollar steadied Tuesday after lacklustre U.S. retail sales data deflated the greenback's tyres, but appetite for the antipodean unit could be tested alongside the nerves of the Federal Reserve (Fed) Wednesday, ahead of an important dialogue between U.S. and Chinese diplomats in Alaska. 

AUD/USD was bought following a surprise fall in February's U.S. retail sales that more-than offset upward revisions to earlier numbers, although intraday gains were fractional and the Aussie's performance was still chequered against other currencies owing in part to lower industrial metals prices.

The oil-linked and North America-based Canadian Dollar topped the board but was followed closely by the safe-haven Japanese Yen and Swiss Franc in testatement of unease among investors and traders ahead of this months policy decision from the Federal Reserve. 

"RBA minutes from the March meeting simply reinforced recent messaging that monetary accommodation is seen needed and will be provided for an extended period. On inflation the minutes detailed that the bank was willing to look through ‘transitory fluctuations’," says Patrick Bennett, a Hong Kong based macro strategist at CIBC Capital Markets. "AUD/USD support is 0.7695-05, and resistance is 0.7775 and then 0.7800." 

Above: AUD/USD shown at hourly intervals alongside GBP/AUD (purple) and 10-year U.S. government bond yield (blue).

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Reserve Bank of Australia (RBA) Assistant Governor Christopher Kent speaks about "Small Businesses Finance in the Pandemic" at an online event hosted by the Australian Finance Industry Association at 23:30 London time on Tuesday, which is the domestic highlight ahead of Wednesday's 18:00 Fed decision.

This week the Fed will either indulge or pour cold water over recent speculation that a brightening outlook for the U.S. economy could lead the bank to end its $120bn per month quantitative easing programme early and begin lifting interest rates as soon as next year, with consequences for the Aussie either way. 

"With Biden’s US$1.9tn stimulus package now signed into law, and checks hitting bank accounts soon, risk-on/ rotation themes should remain well supported though we still see the potential for further yield related disruption as we move through a heavy Central Bank week," says Richard Franulovich, head of FX strategy at Westpac. "With dividend conversion season continuing this week and into April in Australia, the A$ should remain well supported on dips." 

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President Joe Biden's ratification of his $1.9 trillion stimulus package last week and simultaneous suggestion that all Americans could be offered an initial shot from a two-shot coronavirus innoculation by May 01 has somewhat vindicated economists' increased forecasts for U.S. growth and inflation.  

The improving U.S. outlook is a communications challenge for the Fed this week and a possible pitfall for many currencies including the Australian Dollar.

Investors have effectively been kicking sand into the eyes of Fed rate setters when wagering that U.S. interest rates could begin rising next year, wagers which have helped lift American government bond yields at a pace that has at times troubled stock and commodity prices while also triggering profit-taking on bets against the greeenback including in AUD/USD. The latter has helped to lift the Pound-to-Australian Dollar rate in recent weeks.

Above: AUD/USD shown at daily intervals alongside GBP/AUD (purple) and 10-year U.S. government bond yield (blue).

U.S. government spending has gotten some investors fearing a sustained return of inflation, at a point when statistical 'base effects' and supply chain disruptions resulting from the pandemic are beginning to lift consumer prices in what policymakers have so-far chosen to view as a bout of "transitory" inflation.   

But the rub for the U.S. Dollar is that Fed policymakers have stressed repeatedly that their new average-inflation-targeting framework means they need above-target inflation manifested in actual outcomes rather than simply envisaged by forecasts and expectations before they lift interest rates.

They have past form for acting 'dovish' even when all is looking up for the economy. Notably, growth forecasts were improving, the job market had bottomed and inflation expectations were rising when in November 2009 the FOMC announced its second ever quantitative easing programme. 

The U.S. Dollar would likely suffer and the Aussie benefit from any repeat performance or other 'dovish outcome this week, after which an important meeting and dialogue between U.S. and Chinese diplomats in Alaska on Thursday and Friday will quickly dominate the agenda.

"The Biden administration has said it wants to find areas of cooperation with China while maintaining a hardline stance on trade, technology, security and other issues. On March 3, US Secretary of State Antony Blinken said in his first major address that "Our relationship with China will be competitive when it should be, collaborative when it can be and adversarial when it must be," says Qi Gao, a Singapore based strategist at Scotiabank, whose bullish outlook for the Renminbi would typically imply strength ahead for a positively-correlated Australian Dollar. "Top US and Chinese diplomats will hold a two-day meeting next week in Alaska in a bid to reset a volatile but pivotal bilateral relationship. USD/CNH will likely trade lower towards the 6.40 level."

Source: Scotiabank. Click image for closer inspection. 


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