AUD/USD, NZD/USD: Fed Meeting cements shift from China proxy to rates play

AUD/USD, NZD/USD shift focus from China proxies to rate differentials
Fed meeting looms as a pivotal driver for both pairs next week
Hawkish rate signals could deepen bearish momentum for Antipodeans

Overview

AUD/USD and NZD/USD are now behaving more like plays on interest rate differentials than outright China proxies, intensifying focus on what Federal Reserve members may signal about the path for the Fed funds rate over the next two years. The price action in the Aussie and Kiwi was ugly on Thursday, and with momentum still with the bears, downside appears far easier than upside near-term.

China proxy out, rate differentials in

AUD/USD was given every excuse to rally on Thursday but couldn’t, with bullish domestic jobs data and more pledges of policy support in China failing to deliver sustained upside. Instead, a big, definitive bearish pin candle on the daily chart emerged.

Source: TradingView

Upon closer inspection, the notion that the Aussie is purely a China proxy doesn’t hold true right now. AUD/USD is exhibiting a far stronger relationship with yield differentials between the United States and China than with USD/CNH or copper futures. The inverse correlation with yield differentials in the belly and back-end of bond curves has been especially strong over the past month, sitting at -0.9. Not quite perfect, but close.

Source: TradingView

The Kiwi is in a similar position to the Aussie, though its relationship with yield differentials and other China-related proxies is not as strong. There’s some correlation, but it’s not overly robust.

FOMC meeting a key risk event

While the Kiwi’s drivers are less obvious than the Aussie’s, the analysis underscores that next week’s Federal Reserve FOMC decision will likely be pivotal for both AUD/USD and NZD/USD. Updated economic and interest rate projections are likely to influence not only the front-end of the US interest rate curve but also the belly and back-end, which have been driving recent FX market movements.

Jerome Powell’s comments last month, noting that downside risks to the labour market had receded and inflationary pressures were more persistent than envisaged in September, have traders on alert for a potential hawkish cut. A 25bps cut next Wednesday is now considered nearly a lock.

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