AUD/USD Trades Within Head-and-Shoulders Formation Ahead of RBA

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Australian Dollar Talking Points

The outlook for AUD/USD remains mired by a head-and-shoulders formation amid the failed attempt to defend the February low (0.7564), but the Reserve Bank of Australia (RBA) interest rate decision may shore up the exchange rate if the central bank alters the forward guidance for monetary policy.

AUD/USD Trades Within Head-and-Shoulders Formation Ahead of RBA

AUD/USD carves a series of higher highs and lows ahead of the RBA meeting as the board is widely expected to keep the official cash rate (OCR) at the record low of 0.10%, and it seems as though the central bank is in no rush to conclude its quantitative easing (QE) program as “a further $100 billion will be purchased following the completion of the initial program.”

More of the same from the RBA may drag on AUD/USD as the board pledges to “not increase the cash rate until actual inflation is sustainably within the 2 to 3 per cent target range,” and it remains to be seen if the central bank will utilize its emergency measures throughout 2021 as the update to Australia’s Employment report shows the economy adding 88.7K jobs in March versus expectations of a 30.0K rise.

As a result, the RBA may show a greater willingness to shift gears as the central bank acknowledges that “market participants had brought forward their expectations for an increase in policy rates in a number of economies, including Australia, and a batch of less dovish remarks from Governor Philip Lowe and Co. may generate a bullish reaction in the Australian Dollar if the board starts to adjust the forward guidance.

In turn, the decline from the February high (0.8007) may turn out to be a correction in the broader trend rather than a change in AUD/USD behavior as the measured move for the head-and-shoulders formation has yet to play out, and the recent flip in retail sentiment may also end up being short-lived like the activity seen in 2020.

Image of IG Client Sentiment for AUD/USD rate

The IG Client Sentiment report shows 52.54% of traders are currently net-long AUD/USD, with the ratio of traders long to short standing at 1.11 to 1.

The number of traders net-long is 11.10% higher than yesterday and 9.69% lower from last week, while the number of traders net-short is 3.21% higher than yesterday and 0.09% higher from last week. The IG Client Sentiment index has narrowed from 54.55% during the previous week amid the decline in net-long interest, while the small rise in net-short position comes as AUD/USD fails to defend the February low (0.7564).

With that said, the shift in retail sentiment may persist as AUD/USD trades within a head-and-shoulders formation, but the failed attempt to close below the neckline may generate a larger rebound in the exchange rate, with the Relative Strength Index (RSI) reflecting a similar dynamic as the oscillator breaks out of the downward trend from earlier this year.

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AUD/USD Rate Daily Chart

Image of AUD/USD rate daily chart

Source: Trading View

  • Keep in mind, the AUD/USD correction from the September high (0.7414) proved to be an exhaustion in the bullish trend rather than a change in behavior as the exchange rate traded to fresh yearly highs throughout December.
  • At the same time, developments in the Relative Strength Index (RSI)showed the bullish momentum gathering pace as the indicator pushed into overbought territory for the first time since September, with the break above 70 accompanied by a further appreciation in AUD/USD like the behavior seen in the first half of 2020.
  • However, a textbook RSI sell signal emerged following the failed attempt to test the March 2018 high (0.7916), with AUD/USD trading to fresh 2021 lows in February as it failed to preserve the January range.
  • Nevertheless, the pullback from the January high (0.7820) turned out to be a short lived, with AUD/USD trading to fresh yearly highs to negate the scope for a double-top formation.
  • As a result, the decline from the February high (0.8007) may also be another exhaustion in the broader trend, but failure to defend the February low (0.7564) casts a bearish outlook for AUD/USD as a head-and-shoulders formation takes shape in 2021.
  • Need a close below the neckline around 0.7560 (50% expansion) to 0.7570 (78.6% retracement) to bring the downside targets on the radar, but the recent series of higher highs and lows may negate the key reversal pattern especially as the RSI breaks out of the downward trend from earlier this year.
  • The move back above 0.7640 (38.2% retracement) may push AUD/USD back towards the Fibonacci overlap around 0.7720 (38.2% expansion) to 0.7760 (23.6% expansion), which lines up with the 50-Day SMA (0.7717), with the next area of interest coming in around 0.7880 (38.2% expansion).

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— Written by David Song, Currency Strategist

Follow me on Twitter at @DavidJSong

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