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The Australian Dollar fell by the most in four months last week after dovish comments from the RBA caused traders to re-evaluate their expectations for interest rate hikes.

If you recall earlier in 2014 the talk was about how the US economy would strengthen further and the dollar would follow suit as expectations for interest rate rises in the US would push the greenback higher. Then when the data began to come out we started to see a disparity between our expectations for dollar strength and the very economic data that was supposed to underpin it. In other words the reality of the economic data did not support a strong dollar. The Fed continued to taper its liquidity program by $10bn per month but speculators began to bet that this process would have to be parked for the time being if the economy began to cool off. And so we saw pairs like EURUSD continue to trade sideways rather than down and AUDUSD continue to climb to within a few hundred pips of the previous lower top.

However it seems like in the last week or two something has changed. The economic data coming out seems to be building a picture of a more vigorous US economy than was being priced in, and so rather than looking for increasingly softer data we seem to be starting to build in expectations of stronger data. This is no less than what the Fed told us when they said the earlier softer data was down to adverse weather.

The first to crack on May 8th was EURUSD which came within a half dozen pips of 1.40 and closed near the lows at 1.3841. Within a few days it had broken the previous weekly higher low by 1.3671 and any attempts at a rally since have been met with offers. Mario Draggi may soon be announcing a liquidity program of his own in stark contrast to the Fed which is in reverse gear. Second to go was AUDUSD on May 20th which broke the rising channel support that had sustained it, dropping over 100 pips and closing on the dead lows at 0.9231. It has since travelled sideways in a fairly tight range of no more than 60 pips and always closing towards the middle of the range. Is this a flag pattern with the lows at approx. 0.92?

So what’s up? If we are now supposed to expect stronger US economic data against the backdrop of the Federal Reserve continuing to taper by $10bn per month then perhaps currencies like the Euro suddenly don’t look as hot, especially when the ECB may embark on a course that is the opposite of the Fed. Certainly major currencies with higher yields are particularly vulnerable and in this camp the Aussie Dollar firmly sits. The Aussie is exposed to a flight from risk correlated assets and so its break of rising channel support was reasonable and justified. How low can it go? Last year’s drop from 0.9757 to 0.8845 took ten consecutively bearish weeks in a row, we took a breather for two weeks and then it went lower again. History is unlikely to exactly repeat itself but another weekly lower low would put us beneath 0.8659. I remain short.

Gary Comey – www.fxlight.co

Further reading:  Euro Vulnerable To Deeper Losses Against The Australian Dollar