AUD/USD Pullback From 2020 High Fizzles as Fed Balance Sheet Widens

Australian Dollar Talking Points

AUD/USD trades in a narrow range following the failed attempt to test the 2019 high (0.7295), but the Australian Dollar may continue to outperform its US counterpart as the Federal Reserve’s balance sheet climbs back above $7 trillion ahead of the Economic Symposium scheduled for August 27-28.

AUD/USD Pullback From 2020 High Fizzles as Fed Balance Sheet Widens

AUD/USD has appreciated approximately 30% from the March low (0.5506) as the Reserve Bank of Australia (RBA) sticks to a yield-target program, while the Federal Open Market Committee (FOMC) relies on its asset purchases along with its lending facilities to support the US economy.

Looking ahead, the different approach in managing monetary policy may continue to prop up AUD/USD as the reaction to the FOMC Minutes dissipates ahead of the Economic Symposium, and the pullback from the 2020 high (0.7276) may end up being short-lived as the central bank vows to “increase its holdings of Treasury securities and agency residential and commercial mortgage-backed securities at least at the current pace.

Source: FOMC

In turn, the Fed symposium may largely indicate more of the same for the next interest rate decision on September 16, and fresh remarks from Chairman Jerome Powell and Co. may do little to derail the appreciation in AUD/USD as the Fed’s balance sheet climbs above $7 trillion in August.

The widening balance sheet may continue to produce headwinds for the US Dollar as the FOMC appears to be in no rush to alter the path for monetary policy, but the crowding behavior in the Greenback looks poised to persist over the remainder of the month as retail traders have been net-short AUDUSD since April.

Image of IG Client Sentiment for AUD/USD rate

The most recent update to the IG Client Sentiment report shows 43.83% of traders are net-long AUD/USD, with the ratio of traders short to long at 1.28 to 1. The number of traders net-long is 2.48% lower than yesterday and 2.14% higher from last week, while the number of traders net-short is 1.78% lower than yesterday and 13.88% lower from last week.

The rise in net-long position comes as the reaction to the FOMC meeting dissipates, with AUD/USD holding above last week’s low (0.7136), while the decline in net-short interest could be indicative of profit-taking behavior amid the pullback from the 2020 high (0.7276).

With that said, the 2019 high (0.7295) remains on the radar for AUD/USD as the crowding behavior in the US Dollar looks poised to persist, and the recent weakness in the exchange rate may turn out to be an exhaustion in the bullish price action rather than a change in trend as the Federal Reserve remains reluctant to scale back its emergency measures.

However, the technical outlook for AUD/USD is clouded with mixed signals as the Relative Strength Index (RSI) continues to deviate with price, with the oscillator snapping the upward trend established in July after failing to push into overbought territory.

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AUD/USD Rate Daily Chart

Image of AUD/USD rate daily chart

Source: Trading View

  • Keep in mind, the advance from the 2020 low (0.5506) gathered pace as AUD/USD broke out of the April range, with the exchange rate clearing the January high (0.7016) in June as the Relative Strength Index (RSI) pushed into overbought territory.
  • AUD/USD managed to clear the June high (0.7064) during the previous month even though the RSI failed to retain the upward trend from earlier this year, with the oscillator pushing into overbought territory for the fourth time in late-July.
  • The RSI established a bullish trend in July as AUD/USD traded to fresh yearly highs, but the indicator continues to deviate with price as it snaps trendline support after failing to push into overbought territory.
  • Nevertheless, the 2019 high (0.7295) remains on the radar for AUD/USD as it bounces along the Fibonacci overlap around 0.7090 (78.6% retracement) to 0.7140 (23.6% retracement), with the next area of interest coming in around 0.7370 (38.2% expansion).
  • Will keep a close eye on the RSI as it holds below 70 even though AUD/USD trades to a fresh 2020 high (0.7276) in August, but lack of momentum to hold above the 0.7090 (78.6% retracement) to 0.7140 (23.6% retracement) region may bring the 0.6970 (23.6% expansion) to 0.6980 (23.6% expansion) area back on the radar as the bullish momentum appears to be abating.

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— Written by David Song, Currency Strategist

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