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Aussie hits record high on US dollar recycling

The Australian dollar has hit a post-float high of 1.1080, after a higher-than-expected second-quarter inflation print raised the prospect of an interest-rate hike being brought forward.

The Aussie was also the main beneficiary of persistent market fears that the US will fail to agree a long-term solution to reduce its budget deficit before the August 2 deadline. The US dollar ended yesterday (July 26) down against all G10 and principal emerging-market currencies. Traders report $5 billion of US dollar recycling by Asian central banks overnight, with liquid G10 alternatives such as the Aussie being the main beneficiaries.

Support levels for AUDUSD were reported at 1.1010, with resistance levels at 1.1200. Among US dollar buyers, support levels were sought at 1.0980, where Aussie buying among Asian central banks was expected. Australian treasury bill futures slumped by up to 20 basis points – 40bps of cuts had been priced in over the next 12 months.

“Australia’s higher-than-expected Q2 consumer price index reinforces our call for a November rate hike, with the risk that it could be sooner if the unemployment rate falls,” says Citi economist Josh Williamson in a strategy update.

Barclays Capital also calls the CPI print a game-changer for expectations of a rate hike by the Reserve Bank of Australia, suggesting the latter has unfinished business on the tightening front. The central bank’s focus will now switch to domestic factors weighing on the currency, the note suggests. An August rate hike by the RBA remains an outside chance.

Simon Smith, chief economist at broker FXPro, counsels against reading too much support for an RBA rate hike from the figures, however. Some of the strength in the Australian CPI data was down to the impact of floods earlier this year, he says, particularly on food prices. He also notes comments from RBA governor Glenn Stevens that households can bounce back quickly from period of subdued spending.

A vote on raising the US debt ceiling, meanwhile, has been delayed until tomorrow (July 28). Citi suggests that the most likely scenario is a short-term agreement to raise the ceiling, but no credible long-term deficit-reduction plan, possibly still leading to a ratings downgrade. S&P has reiterated its desire to see a $4 trillion reduction in the US deficit over the next 10 years, if the country is to keep its AAA rating.

There is an increasing risk that Congress will fail to raise the ceiling by the August 2 deadline, Citi says, prompting the Treasury to reduce spending sharply and even consider asset sales.

In a strategy update, Deutsche Bank argues that a one-notch downgrade will have limited shock value and will be unlikely to lead to wider contagion, beyond entities directly linked to the US sovereign rating such as state-backed mortgage lenders Fannie Mae and Freddie Mac.

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