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AUD/USD rally cools off ahead of Australia CPI, US FOMC

For the past several weeks, a weakened US dollar that has been weighed down by doubts surrounding an increasingly dovish Federal Reserve has helped push up other key currencies, particularly those whose relevant central banks have been perceived as turning more hawkish. As the Fed downplays the prospects of many more rate hikes going forward, other central banks, including the Bank of Canada and Reserve Bank of Australia, have shown some intentions and indications of pursuing tighter monetary policy.

While the Bank of Canada raised its key overnight rate less than two weeks ago, the Reserve Bank of Australia released minutes last week from its early-July policy meeting in which policymakers were optimistic about the Australian and global economies, suggesting the possibility of tighter policy on the horizon in-line with other major central banks.

Meanwhile, the Fed has recently begun to telegraph a more dovish approach to interest rate increases, with several Fed speakers, including Chair Janet Yellen, having recently talked down the prospects of regular rate hikes going forward.

This week, two key events, both occurring on Wednesday, could make a major impact on the AUD/USD currency pair – the release of Australia’s quarterly Consumer Price Index (CPI) and the Fed’s July policy meeting. As for Australian CPI, Q2 consumer inflation is expected to have risen by 0.4%, which would continue to remain below the RBA’s target. Any upside surprise, however, is likely to provide a strong and extended boost for the Australian dollar.

The FOMC meeting on Wednesday is overwhelmingly expected to produce very little in terms of policy change. While there may be more details on the frequently mentioned balance sheet reduction, the current likelihood of a rate hike on Wednesday (according to the CME Group’s Fed Fund futures pricing) is a mere 3%. And by December, the rate hike likelihood rises only to less than 50%, significantly lower than in previous weeks and months. Overall, despite much talk of shrinking its balance sheet, the Fed has clearly become more dovish in terms of its potential rate hike trajectory.

Ahead of Australia’s CPI release and the FOMC meeting this week, AUD/USD has remained within a sharp uptrend that has recently broken out above progressively higher key resistance levels. Within the past two weeks, these levels have included 0.7750 and 0.7900. After approaching its next major target at the psychologically important 0.8000 level late last week, the currency pair has since pared some of those gains and pulled back to around the 0.7900 level, now as support. If this 0.7900 level holds, the sharp uptrend for AUD/USD has the potential to be extended further, especially if the Fed remains as dovish as it has been recently. In this event, the next major upside targets are at the noted 0.8000 psychological level followed further to the upside by the 0.8100 resistance area.

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