Australian dollar outlook: punching higher on soft US dollar

The Australian dollar roared higher last week with the US dollar collapsing under the weight of the market anticipating a less hawkish Federal Reserve.

Positive sentiment toward risk assets ballooned with the prospect of China coming back online to boost the global economy. Industrial metals soared, further underpinning the Aussie dollar.

Domestic data released during the week revealed strong lagging indicators but soft leading economic gauges.

Retail sales came in at 1.4% month-on-month for November, above the 0.6% forecast and -0.2% previously. The year-on-year figure to the end of November was 7.4% rather than the 7.2% anticipated and 6.9% prior.

The trade surplus for November came in at a colossal AUD 13.2 billion, well above estimates of AUD 11.3 billion and better than AUD 12.2 billion previously. The surge in iron ore, copper, gold, aluminium and nickel will further add to the bottom line of the domestic economy.

Conversely, building approvals month-on-month for November were -9.0%, well below a flat figure anticipated and -5.6% previously. The sector could be a drag on the economy going forward with the RBA’s rate hikes seemingly impacting activity.

Externally, AUD/USD was aided by the closely watched US dollar index (DXY) crashing to its lowest level since June last year as the market appears to be playing chicken with the Fed.

Multiple speakers representing the Federal Open Market Committee (FOMC) said that the Fed funds target rate will go higher than what the market is currently pricing in.

They also said that a rate cut this year is unlikely and that rates will need to stay high for a long time to stamp out inflation. Futures are currently pricing in a rate cut later this year.

The view of the Fed being less hawkish was supported by US CPI decelerating in December but the year-on-year number of 6.5% remains well above the target rate of 2%.

Looking ahead, domestic unemployment data is due out on Thursday, but it is the sways of the US dollar that could be the driving force for AUD/USD.

Perceptions of where the Fed is headed for rates may play a larger role for the ‘big dollar’ and if the market starts believing what thew Fed is saying, it may provide a boost for the greenback, potentially undermining AUD/USD.

The Fed and the RBA will both be deliberating monetary policy at their meetings in early February.

Chart - AUD/USD, iron ore, copper, gold, DXY index

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