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Published On: Wed, Sep 17th, 2014

Is the dollar rally set to continue or a correction is ahead: it all depends on the Fed

Dollar bulls hold their breath, keenly awaiting Fed’s message today; the AUD/USD recovery should not be viewed as a game changer because further losses for the Aussie seem inevitable.

The dollar index continued its steep ascent on diverging policy paths of the Fed, on one side, and the ECB and BOJ, on the other.

The US dollar keeps on floating in a tight range against most other major currencies. With the Fed policy ending later on today traders abstain from making big bets before getting some forward guidance on the future path of interest rates.

The US dollar index is in consolidation mode between 84.04 and 84.59 after an impressive rally last week, which sent it to a 14-month high. The EUR/USD is also range-bounded between 1.2860 and 1.2980, unable to stage a meaningful correction after the recent brutal selloff due to ECB’s fresh policy action. The AUD/USD managed to recover from a 6-month low at 0.8983, hit early on Monday. Given last week’s free fall though, gains for the Aussie look limited on the chart.

The euro zone’s brittle economic state, combined with the looming deflation risk, look sure to force the ECB into accommodative policy for an extended period of time. In contrast, the solid US recovery raises the possibility of the Federal Reserve signaling tightening in the very close future. This monetary policy divergence of the two central banks has been increasing the appeal of dollar-denominated assets for some time.

Last week 10-year Treasury yield saw its heftiest gain in more than a year. Rising interest rates increase the demand for USD, especially against money offering low yield. Such is the case with the yen, which slid to 107.39 last week, a 6-year low against the US dollar. The situation does not seem to be drastically changing today with the USD/JPY currently at 107.17.

The dollar’s firmness is fairly logical given the solid US recovery. The current positioning on the forex market reflects growing expectations of the Fed, at least hinting on a rate hike, on its meeting finishing tomorrow. Such a message could come in the form of the central bank missing to mention its commitment to keep interest rates at present levels for a considerable time.

 The latest victim of the US dollar strength was the Aussie. The latter lost about 4 cents of its value to the greenback. The spectacular AUD/USD selloff lost steam this morning at a 6-month low of 0.8984. Although the latter, coinciding with the 0.618 Fibonacci retracement of the ascent from 0.8660 to 0.9505, would probably provide some short-term support, further losses are expected for the Australian dollar.

The recent weakness of the Aussie should have delighted the Reserve Bank of Australia. Governor Stevens and other RBA bankers have complained on a number of occasions that the Australian dollar has been higher than what fundamentals would justify. The recent softness of the currency will give exporters some breathing space, thus stimulating the economy.

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