USD Losses to Be Short-Lived, AUD Trend at Risk on Slower Inflation 

The Dow Jones-FXCM U.S. Dollar Index (Ticker: USDollar) remains 0.07 percent higher from the open after moving 53 percent of its average true range, and the recent weakness in the greenback may be short-lived as the rebound in the 30-minute relative strength index gathers pace. As the index continues to mark a series of higher highs paired with higher lows, we should see the upward trending channel from earlier this month continue to take shape, and we will maintain our bullish forecast for the greenback as it builds a base above the monthly low (9,980). In turn, we should see the dollar continue to retrace the decline from the previous month, and the bullish sentiment surrounding the USD may pick up over the near-term as the Federal Reserve moves away from its easing cycle.

Although the slew of dismal developments coming out of the world’s largest economy dampened the outlook for growth and inflation, we expect the FOMC to maintain its current policy throughout the remainder of the year as policy makers continue to see a limited risk for a double-dip recession. Indeed, Goldman Sachs scaled back their bet for another round of quantitative easing at the September 13 meeting, but saw scope for QE3 towards the end of the year amid the ‘sluggish’ recovery. In contrast, we do not expected to see additional asset purchase from the FOMC as economic activity gradually gathers pace, and Fed Chairman Ben Bernanke may continue to soften his dovish tone for monetary policy amid the stickiness in underlying inflation. Nevertheless, as the USDOLLAR continues to come off of trendline support, we may see the index make a run at the 78.6 percent Fibonacci retracement around the 10,118 figure, but we would like to see a close above the 20-Day SMA (10,046) to see additional dollar strength over the remainder of the week.

The greenback strengthened against two of the four components, led by the 0.39 percent decline in the Euro, while the Australian dollar advanced 0.08 percent amid the pickup in market sentiment. However, we may see the high-yielding currency come under pressure should the economic docket for the region show easing inflation expectations paired with weaker wage growth, and we may see the AUDUSD fail to maintain the upward trending channel from June as market participants see the Reserve Bank of Australia carrying out its easing cycle over the coming months. According to Credit Suisse overnight index swaps, market participants still see borrowing costs falling by at least 50bp over the next 12-months, and the interest rate outlook continues to instill a bearish outlook for the aussie-dollar as the pair appears to be carving out a lower top around the 1.0600 figure.

--- Written by David Song, Currency Analyst

To contact David, e-mail dsong@dailyfx.com. Follow me on Twitter at @DavidJSong.

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