The Australian Dollar has been under pressure due to the ongoing USD strength triggered by high US inflation. The US 10y yield has breached 1.6% after the recent US inflation data came in at multi-year high.  The Dollar Index (DXY) has traded above 95.00 illustrating the broad based Dollar move.

In October 2021, annual inflation in the United States advanced to a three-decade high of 6.2 percent, encouraging the anticipation of early Federal Reserve interest rate hikes and causing the latest Dollar surge. 

On the domestic front, the Reserve Bank of Australia has hinted that the emergency measures introduced to combat the Covid impact will now be withdrawn. The RBA acknowledged rising inflationary pressures and now markets predict a rate hike by about end of 2022. The RBA stance has buffered AUD from a large depreciation move, unlike EUR. The ECB has been very dovish with respect to rates and that divergence is reflected in the EURUSD level and a fall in EUR/AUD cross. 

Australia has had a good first half of exports to China despite the sour relationship between the two countries. Given that Iron Ore was not part of China sanctions, and helped by the sky-high prices of Iron ore, Australia has managed to perform well in the export sector. Further, demand for commodities across the board and the sharp rise in commodity prices have helped the Australian economy buffer some of the stress due to Covid lockdowns. The Australian GDP is forecast to grow at 3% this Fiscal (down from 4% projected earlier), despite a contraction last quarter.

In all, economic factors are looking up for AUD, buffering a sharp Dollar induced depreciation in the Australian currency.  We expect that the ongoing Dollar strength to deepen as the FOMC is forced to be more aggressive than what their current stance projects. US inflation has been very stubborn and the longer the dovish stance of the FOMC, the higher are the chances of a sharp rearguard action leading to market panic and risk aversion. Until now, equity markets across the world are holding up well despite the start of the taper of US bond purchases. But the risk of a large risk aversion wave remains tangible.

We expect the AUD/USD pair to move towards 0.71 levels gradually as the Dollar strength deepens. In the eventuality of an equity market correction, AUD can breach the 0.7 mark and lead towards 0.68 over the next few months.

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