If recent predictions of a significant equity market correction before year-end materialise, the Australian dollar could head to a fresh 2021 low, after showing remarkable resilience in recent weeks despite growing concerns over Chinese and global growth and a huge fall in iron ore prices.
There is a view percolating in equity and bond markets that the global economy may be in a period of sluggish growth and persistent inflation. Central banks have historically struggled to deal with 'stagflation' and been more prone to policy mistakes under those conditions.
Federal Reserve Chair Jerome Powell contends inflationary pressures are transitory and his European Central Bank counterpart Christine Lagarde will likely reiterate that view after the ECB meeting later Thursday, but the bond markets aren't so sure.
and euro zone bond yields have risen recently despite a run of below-forecast economic data, as inflation concerns hold sway nL1N2Q30H2. If the major central banks are wrong, or at least perceived thatway, it could be the catalyst for an overdue mid-cycle correction in equities.
A Morgan Stanley analysis of G10 FX option positions found the market is short USD, particularly against "risk and commodity-sensitive currencies like NZD, AUD and NOK." Those currencies will likely be the hardest hit if equities experience a significant correction.
An AUD/USD break below the 21-day moving average support at 0.7309 would shift the pressure to the downside.
A break below the 61.8 Fibonacci retracement of the recent 0.7106-0.7477 rise at 0.7248 would set the stage for a test of the year's low at 0.7106.
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