AUD/USD has eased back from fresh 34-month highs in recent trade as traders eye incoming risk events US-side. Though strong services PMI numbers were broadly shrugged off, AUD looks set to continue to benefit from reflation trade bets. AUD/USD bulls took their feet off the gas in the second half of Tuesday’s US session, but not before driving the pair to fresh 34-month highs at 0.77774. The pair closed Tuesday FX trade with gains of around 1.2% or 90 pips. As the Wednesday Asia Session gets underway, the Aussie is easing back from highs but remains bid above the 0.7750 mark and above the 31 December and 4 January highs at just above 0.7740 for now. AUD upside was driven on Tuesday by a market upping its bets on inflation in 2021 and beyond. Reflation trade Price action on Tuesday was typical of a market betting on higher inflation (in the US) in the months and years ahead. Nominal US bond yields saw a substantial rise and the nominal yield curve saw substantial steepening; the US 10-year yield rose to 0.955% (traders are on notice for a move above 1.0%), up 3.8bps on the day while the 30-year yield was up 4.8bps to 1.704%. Meanwhile, the 2s10s spread rose 3bps to 83.2bps and the 5s30s spread rose to 134.6bps, its highest since 2016. As a reminder, higher inflation expectations reduce the value of a bond, thus pushing up its yield, and longer-maturity bonds are more heavily exposed to changes in inflation expectations. Despite the rise in nominal yields, real US yields remain close to record lows, with the US 10-year TIPs yield (the real yield on a US 10-year bond) remaining close to record lows at -1.08%. The widening of the divergence between nominal and real US yields saw break-even inflation expectations rising; the 10-year breakeven inflation expectations (the difference between the nominal and real 10-year US bond yields) rose back above 2.0% and remains at highs since Q4 2018. Bets on inflation were not only seen in US bond markets but also global commodity markets, which were bid across the board. Commodity-export dependent currencies such as AUD stand to benefit significantly if commodity price inflation continues. As mass vaccinations get underway in major global markets and traders bet on a strong recovery in global economic and trade conditions in the second half of 2021 and beyond against the backdrop of unprecedented levels of fiscal and monetary stimulus in 2020, commodity price appreciation (as well as strength in the likes of AUD) looks set to continue. Aussie Data Australian Markit Services PMI data for November was released at 22:00GMT and rose to 57.0 from November’s reading of 55.1, its highest reading in five months fourth consecutive monthly improvement. “Survey members often cited that a further easing in coronavirus disease 2019 (COVID-19) restrictions had provided a boost to activity throughout the final month of 2020,” said IHS Markit. “The picture for the Australian services economy remains positive at the end of the year, with expectations for an expansion in activity remaining at high levels. However, concern surrounding the pandemic persists with the re-imposition of restrictions in southern states following a resurgence in infection rates” concluded the data firm. All very well and good for AUD then, but AUD is much more focused on developments stateside for the rest of the week… Incoming US risk events A number of US news organisations have said that they expect to be able to call both of Tuesday’s Senate elections by Wednesday morning (US time). There is a risk the outcome will be closer than expected and remain unknown for a few days, which might well benefit havens such as JPY at the expense of USD and more risk-sensitive currencies such as AUD. The outcome that would trigger the most volatility would be an unexpected Democrat victory in both elections; nominal US bond yields would undoubtedly move much higher in anticipation of further debt-funded US fiscal stimulus, with many pointing to the 1.0% level as a key area of resistance for the US 10-year bond yield. A break above this could trigger a broader sell-off in US government debt markets as trend-following algorithms join the selling, traders have speculated. How this would impact FX markets is unclear; real US yields might actually move lower if expectations for further stimulus give a further boost to inflation expectations. This might end up being a USD negative, though if the market reacts to a surprise Democrat victory in a risk on fashion, then safe-haven currencies like JPY are less well placed to gain versus the US dollar compared to the likes of AUD or NZD. Aside from the Senate elections, eyes will also be on Congress, who are slated to certify the result of the November 2020 Presidential election by Thursday. The result is expected to be certified, though a large number of Senate and House Republicans will contest the election which might result in a few hiccups along the way. Meanwhile, FX markets will also need to keep an eye on the next batch of ISM PMI numbers, this time for the service sector (released on Thursday). Official jobs data will be released on Friday. Both will give a timely update as to the state of the US economy in December. Tuesday’s ISM manufacturing numbers were strong across the board, but the sector is more immune to Covid-19 lockdown restrictions and is likely riding the wave of a better recovery elsewhere in the global economy (such as in Asia). FX Street FX Street FXStreet is the leading independent portal dedicated to the Foreign Exchange (Forex) market. It was launched in 2000 and the portal has always been proud of their unyielding commitment to provide objective and unbiased information, to enable their users to take better and more confident decisions. View All Post By FX Street FXStreet News share Read Next Millions more covid-19 vaccines on way for UK – Times FX Street 11 months AUD/USD has eased back from fresh 34-month highs in recent trade as traders eye incoming risk events US-side. Though strong services PMI numbers were broadly shrugged off, AUD looks set to continue to benefit from reflation trade bets. AUD/USD bulls took their feet off the gas in the second half of Tuesday’s US session, but not before driving the pair to fresh 34-month highs at 0.77774. The pair closed Tuesday FX trade with gains of around 1.2% or 90 pips. 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