AUD/USD Outlook: Weak Australian Data Meets Relentless Risk Appetite

• Equities and volatility driving AUD/USD, not rates
• August RBA hike odds back near coin flip territory
• AUD/USD wedge compression warns breakout nearing
• .7080 support, .7180 resistance nearby levels to watch

Risk Appetite Dominating

AUD/USD is continuing to shrug off the sharp curtailment in hawkish RBA pricing seen following Australia’s weak April employment report. That’s because the Aussie remains more closely tied to equities and volatility than domestic rate expectations right now, as shown in the correlation matrix below.

Source: TradingView

Correlation coefficients measure the strength and direction of two variables. A reading of 1 means two variables move perfectly together, while -1 means they move perfectly in opposite directions. Readings near zero suggest little consistent relationship exists. Importantly, correlations should be scrutinised thoroughly as strength does imply causation. 

Right now, the matrix points to AUD/USD maintaining strong and persistent relationships with equity futures and volatility across both five and 20-day windows, while correlations with Australian-US yield spreads have become far more unstable over shorter-term horizons.

Markets Scale Back RBA Rate Hike Bets

The instability in shorter-term rate spread correlations does not mean Australian interest rate expectations have become irrelevant altogether. In fact, as shown in the Bloomberg implied RBA rate hike probability graphic below, swaps markets have undergone a significant repricing over the past month, with traders rapidly scaling back expectations for further tightening following the RBA’s May meeting and last week’s weak labour market report.

Source: Bloomberg

Only a few weeks ago, overnight index swaps were flirting with the idea the cash rate could rise above 5% this cycle, with an August hike viewed as borderline fully priced at one stage. Now, August tightening odds have fallen back towards a coin flip, while a full additional 25bp increase is not fully priced until November, with markets increasingly viewing that as potentially the final move of the cycle.

However, markets are still largely debating fewer hikes rather than the prospect of eventual rate cuts. That matters because rate differentials often become a far more dominant driver for currencies when traders sense a genuine turning point in the policy cycle is approaching.

RBA’s Dual Mandate Matters

Source: LSEG

While such a moment may still seem premature given inflation risks remain elevated, Citi’s Australian economic surprise index suggests the possibility may be drawing closer than many expect, with the gauge now sitting near its weakest levels since July as economic data increasingly undershoots expectations even before the full effect from tighter policy and budget pessimism has likely been felt.

That may become increasingly important given the RBA operates under a dual mandate incorporating both inflation and employment outcomes, meaning the risk of the bank signalling an extended pause cannot be entirely ruled out.

AUD/USD Coiling Within Compression Structure

AUD/USD may have taken a hit following the release of the weak April jobs report, but as seen in the price action on the H4 timeframe, that didn’t last for long as buoyant risk appetite reasserted control, helping the pair rebound during the North American session on reports another “imminent” peace deal between the US and Iran.

While that looks to be nothing more than fake news after the apparent source shot down the rumours, it still had the desired effect in pushing the Aussie higher, reinforcing the broader theme that markets remain far more responsive to swings in sentiment than domestic macro developments right now.

Souce: TradingView

As a result of the whipsaw, headline-driven price action, what’s become apparent on the charts is the compression structure AUD/USD finds itself coiling within, with three confirmed touches of downtrend resistance and three confirmed touches of uptrend support recorded over the past few days. That suggests traders should be alert to the risk of a potentially violent breakout in the coming sessions as the range continues to narrow.

While the Aussie entered the wedge from above after breaking the uptrend that had been in place through April and early May, that does not assure the eventual break, if we get an obvious one, will occur to the downside. Markets remain quick to latch onto good news vibes right now but reluctant to retain bearish positions for long, meaning it could just as easily resolve to the topside too.

The oscillators reinforce that message with RSI (14) trending higher and now sitting around the neutral 50 level while MACD continues to work its way back towards flipping positive, having already crossed above the signal line from below. The overall message remains neutral on directional risks for now, leaving price action within the structure carrying additional weight when assessing setups.

For those looking at shorter-term setups, .7140 remains relevant having acted as both support and resistance over the past week. Should we eventually see a breakout from the structure with energy behind it, levels of note on the topside include .7180, .7200 and the broader .7260 to .7283 zone, the latter an area where the Aussie previously struggled to extend gains despite a backdrop that should have favoured upside.

On the downside is where things get more interesting technically, with a break beneath .7080 support potentially opening the door for a decent bearish unwind given there is little meaningful support until the early April breakout zone near .6963. .7060 and .6990 are intermediate levels to watch alongside psychologically important support at .7000.

Warsh Speech, Gulf Headlines in Focus

Looking ahead, markets may get another burst of risk appetite later today should incoming Fed Chair Kevin Warsh talk up the prospect of lower US interest rates during his inauguration speech. Beyond that, though, geopolitical headlines look likely to remain the dominant near-term driver for AUD/USD given the lack of major US and Australian economic data releases ahead, especially with the US heading into the Memorial Day holiday on Monday.