The US dollar pared some of its substantial earlier gains on Tuesday after Federal Reserve Chair Janet Yellen said in a speech that the Fed "may have misjudged the strength of the labor market, the degree to which longer-run inflation expectations are consistent with our inflation objective, or even the fundamental forces driving inflation." In making this admission, Yellen indicated that the Fed may need to make a dovish shift in monetary policy, potentially slowing the rate of policy normalization, interest rate increases, and removal of accommodation.
Despite these unexpectedly dovish statements from Yellen and some resulting pressure on the dollar, the greenback was still able to retain most of its recent gains from its multi-year lows earlier this month. Additionally, the market-viewed probability of a December rate hike continued to run high after the speech, well above 70%.
One of the key currency pairs affected by the US dollar’s recent rebound has been AUD/USD. After riding a sharp three-month incline from early June to Early September, the currency pair hit a high just slightly above the key 0.8100 resistance level before reversing to the downside as the heavily-pressured US dollar finally began to recover. AUD/USD then went on to break down below the 0.8000 level, a key uptrend line extending back to early June, and the 50-day moving average.
Despite Yellen’s mostly dovish words on Tuesday, market expectations for higher interest rates from the Fed continue to run strong. As for the Reserve Bank of Australia, the RBA statement earlier this month highlighted improving conditions in the Australian and global economies, including strong employment growth, but also warned of weak wage growth and low inflation. Overall, expectations for any near-term rate hike from the RBA are low. Given the differing market expectations for US and Australian interest rates going forward, AUD/USD could be poised for further losses, especially after the currency pair’s recent overextended run-up. With any downside follow-through on the current breakdown, the next major bearish target in the short-term is around the key 0.7750 support area.