AUD/USD and NZD/USD Fundamental Daily Forecast – Traders Waiting for Details of Fed Balance Sheet Reduction

The Australian and New Zealand Dollars are recovering on Wednesday’s after yesterday’s plunge, following the Reserve Bank of Australia’s interest rate decision and monetary policy decision.

At 0624 GMT, the AUD/USD is trading .7625, up 0.0022 or +0.28% and the NZD/USD is trading .7286, up 0.0003 or +0.04%.

The Aussie Dollar dropped sharply in reaction to the Reserve Bank governor’s statement, despite the RBA holding interest rates steady for the eleventh straight month.

The AUD/USD plunged because the Aussie Dollar bulls, who bought the idea that we are in the midst of a wave of global monetary tightening, were disappointed by the RBA’s statement. They were disappointed that RBA Governor Lowe didn’t join central bankers from the European Central Bank, the Bank of England and the Bank of Canada, in issuing hawkish remarks about the direction of interest rates.

In other news, late Tuesday, the GDT Price Index came in 0.4% lower.

Early Wednesday, in Australia, the AIG Services Index increased to 54.8 from 51.5 and in New Zealand, the ANZ Commodity Prices rose 2.1%. This was lower than the 3.2% previous read.

In China, the Caixin Services PMI was 51.6, lower than the forecast and previous read.

Forecast

Short-covering and position-squaring ahead of the release of the minutes from the Fed’s June monetary policy minutes are giving the AUD/USD and NZD/USD a slight boost. Most of the price action is related to the weaker U.S. Dollar rather than stronger Australian and New Zealand Dollars.

The Fed minutes, due to be released at 1800 GMT, will reveal information about the timing of the next Fed rate hike. Given the recent comment from Fed Chair Janet Yellen and other Fed officials, I expect the minutes to be hawkish in regards to the rate hike. I don’t think there is any doubt they are going to say there will be one more rate hike.

The key issue in the minutes will be whether the Fed offers up some details of the debate around balance sheet reduction.

Traders are hoping for more details of the scale, timing and interaction of this trimming of the balance sheet with the pace of the rate hikes. With this information, investors will gain a better idea of how the liquidity trade will unwind. The liquidity is the $4.5 trillion in debt on the Fed’s balance sheet.

Traders need to know the details of the Fed’s plan because the debt it will be trimming is what the central bank used to help the U.S. overcome the financial crisis.

If the Fed is perceived as pulling the stimulus too quickly, the U.S. Dollar will probably rise and the Australian and New Zealand Dollars should drop. If the Fed decides to withdraw gradually then we may see the AUD/USD and NZD/USD firm.