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  • AUD/USD managed to squeeze out fresh annual highs on Wednesday morning at 0.75785, but has since reversed to the 0.7560s.
  • Despite soft US retails sales numbers, traders are keeping their powder dry ahead of Fed’s monetary policy announcement at 19:00GMT.
  • US fiscal stimulus optimism is likely to keep the likes of AUD supported, even if the FOMC underdelivers on Wednesday.

AUD/USD managed to just about set fresh annual highs in the European morning session of just below 0.7580, but the pair since backed off highs to trade in the 0.7560s. At present, the pair trades flat on the day, in fitting with a subdued market feel in US equity and crude oil markets (the S&P 500 trades flat and WTI trades half a percent lower), amid typical pre-FOMC meeting caution.

AUD to remain supported as markets bet on US stimulus

Though stocks, crude oil markets and FX markets are a little tentative ahead of the FOMC meeting later in the day, bond markets are betting that US Congressional leaders will soon be able to agree upon further Covid-19 fiscal aid; US bond yields are up (10-year bond yield +2bps on the day), the curve is steeper (2s/10s spread is up 2bps) and 10-year Breakeven inflation expectations have risen above 1.9% for the first time since May 2019, all in a sign that bond market participants are betting on 1) increased Treasury debt issuance to fund stimulus and 2) that stimulus will increase inflation outcomes over the next 10 years.

This “reflation” narrative is likely to keep risk assets the likes of AUD supported, meaning more gains in AUD/USD might well be instore. All the while, higher inflation expectations are likely to keep US real yields subdued (the 10-year TIPS yield is still currently below -1.0%), which keeps alive the incentive to borrow money in USD (and subsequently sell the dollar) in order to fund carry trades to higher-yielding assets (such as equities or emerging markets currencies).

While there is a risk that the Fed, who release their latest monetary policy decision at 19:00GMT, might underwhelm some market participants who had been hoping for more monetary easing (the Fed are unlikely to increase the pace of monthly asset purchases, and will likely instead opt to give guidance as to how long these purchases will continue), the narratives outlined above are likely to cap any USD gains.

AUD/USD ignores US retail sales and domestic Aussie developments

Ugly US Retail Sales numbers for November show that the US economy is hurting as a result of rising Covid-19 cases and associated economic restrictions; headline Retail Sales dropped 1.1% (versus expectations for a drop of 0.3%) and Core Retail Sales dropped 0.9% (versus expectations for a 0.1% rise), while the Control group (which gives a better indication as to consumer spending within the quarterly GDP report) dropped 0.5%, worse than expectations for a rise of 0.2%. Control group retail sales have now been negative two months in a row; a third negative number in December will raise the risk that Q4 GDP growth in the US has been negative.

But USD was largely unresponsive to the data and the likes of AUD/USD barely moved. Indeed, the release of the US Currency Manipulation report, which came out at the same time as the US data seemed to steal the limelight at the time. Australia was not mentioned in the report, but the US did urge China to improve FX management transparency, though this did not hurt CNH (or currencies correlated to CNH such as AUD).

AUD has also largely shrugged off overnight news that numerous Australian coal-loaded ships remain stranded off the coast of China, though Chinese officials have denied that there is an official ban on Aussie coal. Meanwhile, Australian Trade Minister Simon Birmingham will reportedly ask the World Trade Organisation to intervene in its dispute with China over barley tariffs and apparently expects other nations to get involved.