AUD/USD and NZD/USD: Fed Meeting Signals Shift from China Proxy to Interest Rate Focus

Market Shifts: AUD/USD and NZD/USD Focused on Rate Differentials

• The dynamics of AUD/USD and NZD/USD are increasingly influenced by interest rate differentials rather than the performance of China.
• Next week’s Federal Reserve meeting is anticipated to be a critical factor for both currency pairs.
• Hawkish indications from the Fed may exacerbate bearish trends for the Australian and New Zealand dollars.

Current Market Overview

AUD/USD and NZD/USD are evolving into instruments reflecting interest rate differentials rather than mere China market proxies. The spotlight now falls on the Federal Reserve’s guidance regarding the future of the Fed funds rate over the forthcoming two years. Recent price behavior of both the Aussie and Kiwi showed significant bearish movements, suggesting that further declines could be more likely in the near term than recoveries.

Shifting Focus from China to Interest Rates

On Thursday, AUD/USD had multiple opportunities for a rally fueled by positive domestic job statistics and additional pledges of economic support from China, yet it failed to maintain upward momentum. Instead, a pronounced bearish pin candle materialized on the daily chart.

Upon further analysis, it’s evident that the relationship of AUD/USD with yield differentials between the US and China is now more pronounced than its correlation with USD/CNH or copper futures. Over the past month, the inverse correlation with yield differentials in the intermediate and longer-term bond markets has been notably strong, registering at -0.9.

The New Zealand dollar exhibits a similar, albeit slightly weaker, correlation with yield differentials compared to the Australian dollar.

FOMC Meeting: An Important Risk Event

Although the factors driving the Kiwi are less apparent, the upcoming Federal Reserve FOMC decision is poised to be crucial for both AUD/USD and NZD/USD. The release of updated economic projections and interest rate forecasts may significantly influence the US interest rate curve, impacting recent foreign exchange movements.

Comments from Jerome Powell, where he indicated that downside risks to the labor market had lessened while inflationary pressures remained more intense than anticipated, have traders on alert for a potential hawkish signal. A 25 basis point cut seems increasingly likely for next Wednesday.

Fed Expected to Modify Rate Cut Outlook

With projections indicating potential undershooting of unemployment and overshooting of inflation compared to the Fed’s September estimations, the market is keenly focused on the Fed’s forthcoming signal regarding the pace of expected easing for the next year. A shift in the neutral rate estimate could also occur.

Three months ago, the prevailing views pointed to 100 basis points of cuts, with a neutral rate of around 2.9%. However, given the latest data, these forecasts now seem too accommodating, suggesting that the updated FOMC dot plot could signal as few as one or two rate cuts in 2025. Maintaining the previous expectation of four cuts could raise concerns regarding the Fed's dedication to addressing inflation.

Additionally, adjustments to long-run projections for the neutral policy rate may signal a figure significantly higher than earlier estimates. If estimates shift to 3.2% or beyond, this could instigate a considerable rise in US Treasury yields, adversely affecting the Aussie and Kiwi.

Market Readiness for a Hawkish Adjustment

Traders are positioning themselves for a hawkish modification to the Fed’s outlook, as indicated by the movements in US interest rate futures, where both two-year and ten-year contracts have shown signs of breaking down recently.

Ten-year Treasury note futures have undergone a significant downturn, indicating a potential shift to rising US Treasury yields and a strengthening dollar against both AUD and NZD.

AUD/USD: Bearish Control Persists

Bearish control remains firmly in place for AUD/USD as the most recent bearish reversal occurred despite positive news both domestically and internationally.

Currently, AUD/USD is moving within a falling wedge pattern that intersects with crucial uptrend support that dates back to October 2022. Although price action has fluctuated recently, the overarching trend continues to be bearish. Observations indicate lower highs and lower lows, coupled with bearish signals from momentum indicators—suggesting the need for selling rallies and looking for downside breaks until downtrend resistance is convincingly breached.

A potential strategy to consider would involve selling if AUD/USD breaks below Wednesday’s low of 0.6350, with a tight stop loss set above this level or the preceding uptrend and targeting a drop to 0.6270.

NZD/USD: Potential Breakdown Imminent

The technical outlook for NZD/USD suggests an even graver situation than that of its Aussie counterpart, as the pair appears poised for a potential breakdown from its current falling wedge pattern. A breach of the November 2023 lows could reveal limited support below, potentially targeting levels as low as 0.5600.

Traders might consider short positions if the price maintains or extends this break, establishing stop losses above 0.5774 or 0.5800 based on individual risk preferences.