AUD/USD drops as the US dollar soars through 105 the figure, DXY

• AUD/USD bears are moving in as the US dollar strengthens in risk-off. 
• DXY has rallied to beyond 105 the figure, dragging commodity currencies lower. 

At 0.6875, AUD/USD is lower on the day by some 0.4% as the US dollar springs back to life, rallying through the 105 figure as measured against a basket of currencies via the DXY index. The dollar index (DXY), which measures the greenback against six counterparts, ticked up 0.51% to 105.08. The two-decade high of 105.79 was struck on June 15. Quarter-end rebalancing of portfolios is also feeding into higher volatility in financial markets.

The greenback has edged higher on Wednesday as the euro gave back earlier gains despite European Central Bank President Christine Lagarde saying the era of ultra-low inflation that preceded the pandemic is unlikely to return. The ECB is widely expected to raise interest rates in July for the first time in a decade, following its global peers, to try to cool accelerating inflation, though economists are divided on the magnitude of any hike. 

Federal Reserve chair Jerome Powell said there was a risk that interest rate increases will slow the economy too much, but persistent inflation was the bigger worry. Additionally, US stocks fell on Wednesday as traders' concern over the impact of hefty rate increases on the US economy bites. US data showed that growth contracted in the first quarter amid a record trade deficit. This is on the heels of a report from Tuesday that showed consumer confidence hit a 16-month low.

Eyes on the RBA

Meanwhile, the Aussie had otherwise found some support on Wednesday as upbeat domestic data provided a temporary distraction from worries about a global recession. reuters reported that Australian Retail Sales surprised with a solid increase of 0.9% in May handily topping forecasts of a 0.4% gain. The news agency reported that Sales were up a sizable 10.4% on May last year, though some of that is due to higher prices rather than volumes.

The data has encouraged demand for the Aussie due to the expectations that the Reserve Bank of Australia (RBA) will have more confidence that consumers can handle higher interest rates as it prepares for another likely hike at its July policy meeting next week.  RBA Governor Philip Lowe has previously suggested that drastic tightening would seriously damage the economy. Rates are seen up around 3.25% by the end of the year and near 4% in 2023 and investors are odds-on for another rise of 50 basis points to 1.35%, and for a similar move in August.

Net AUD short positions fell for a third consecutive week following the hawkish comments from RBA Governor Lowe and more optimism regarding the outlook for China’s economy could bring further support in the next set of data. In this regard, we saw the Aussie rally when China slashed the quarantine time for inbound travellers by half on Tuesday. Higher commodity prices have also had a positive impact on Australia’s terms of trade. 

''We expect AUD/USD to hold close to current levels on a 1-month view and rise moderately to the 0.73 area by year-end,'' analysts at Rabobank said.