Is the Australian inflation miss the turning point for the Aussie dollar?

Australian inflation was weaker than expected in the first quarter, and the market now thinks it’s more likely the Reserve Bank of Australia will be forced to cut interest rates. The Aussie dollar fell in the wake of the inflation number, and technical analysis also suggests that the recent rally may be over.

Source: Bloomberg

The Australian dollar fell after inflation as measured by the Consumer Price Index came in well below market expectations, and speculation has risen that the Reserve Bank of Australia (RBA) will be forced to cut rates in coming months. That could mean an end to the recent rally in the Aussie dollar.

Australian CPI in the first quarter came in at 1.3%, well below the 1.7% year-on-year increase the market was expecting and the 2% increase predicted by the monthly TD-MI CPI gauge. The Aussie dollar promptly declined 1.5% when the figure was released. Key core inflation measures were even more worrying, with the Trimmed Mean CPI and Weighted Median CPI declining to their weakest levels on record.

The bond market is now pricing in a more than 53% chance that the RBA will cut rates at its meeting on 2 May, and a rate cut by September has now been fully priced in.

Short-term volatility in the Aussie dollar is likely to continue as the US Federal Reserve and Bank of Japan (BoJ) monetary policy meetings take place. A more hawkish Fed statement, suggesting near-term US interest rate increases could be on the cards, could accelerate the Aussie’s move to the downside.

If we look at the longer term trend for the Aussie dollar through the Ichimoku Cloud indicators, today’s move is not yet a decisive reversal in the Aussie dollar’s uptrend. While the daily price candle has broken through the red Kijun-sen (baseline), I would be looking for the blue Tenkan-sen (Conversion line) to break through the Kijun-sen as well to confirm that the uptrend may be over. The US$0.76 mark also looks like a key level of support based on where the cloud formation is. A close below US$0.76 would not only see the price begin to break into the cloud formation, but also see the lagged orange Chikou Span line break through the price line and the Tenkan-sen, which strongly indicates that the uptrend is over.

Other indicators are also signalling that the Aussie dollar is primed for a reversal. The weekly reported futures net positioning in the Aussie dollar reached its highest level last week since the start of September 2015. This implies that speculators have become extremely bullish on the Aussie dollar, but as the chart shows, in September last year this level of extreme futures positioning in the Aussie dollar prompted an immediate sharp reversal.

The Risk Reversal in the Aussie Dollar, which is the price difference between out of the money call and put options, is also beginning to show that the market thinks the Aussie dollar might be ready for a decline. The Risk Reversal indicates the relative cost of buying calls or puts, and the higher the value the market is putting on either one shows where market participants think the Aussie dollar will be moving. The relative cost of calls peaked at the start of April, and market participants are beginning to pile into puts at the moment.

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