$A rockets higher on dovish Fed

The Aussie dollar rocketed higher and remained elevated for most of Wednesday as the US Federal Reserve signalled interest rates would remain low amid global growth uncertainty.

Investors fled the greenback, forcing the Aussie more than a cent higher. It rose from lows near US75.10¢ to highs of US76.48¢ just before noon. By Wednesday afternoon the Aussie had settled a little to US76.23¢.

Five factors driving the Aussie dollar

Interest rate policy and the price of iron ore are two of five key factors, which can determine the rise and fall of the Australian dollar.

On Tuesday night in New York, US Federal Reserve Chair Janet Yellen said it was appropriate for the Fed to proceed "cautiously" in hiking interest rates.

"Developments abroad imply that meeting our objectives for employment and inflation will likely require a somewhat lower path for the federal funds rate than was anticipated in December," when the Fed raised rates for the first time in a decade, Yellen said at the Economic Club of New York.

The Australian dollar is at its highest level since May.
The Australian dollar is at its highest level since May.  Photo: Rob Homer

"Given the risks to the outlook, I consider it appropriate for the Committee to proceed cautiously in adjusting policy," Yellen said.

The US dollar dropped sharply on the news, with the Bloomberg Dollar Spot Index headed for its worst month in five years.

That said, Yellen's comments comforted markets which had been hanging out for confirmation regarding the outlook for US interest rates since the Fed at its last meeting reduced the expected pace of increases this year from four to two. 

"Her comments imply that if it were up to her alone, rates would remain unchanged in April and June," said Kathy Lien, managing director of FX strategy for BK Asset Management. 

The dollar shot up after Yellen spoke on Tuesday in New York.
The dollar shot up after Yellen spoke on Tuesday in New York. 

"Her dovish comments reignited the decline in the dollar and we believe there could be further losses including a move to 112 for USD/JPY and a rally to 1.1350 for EUR/USD before stabilisation."

Recent inflationary figures came in below expectations this week, further compounding US dollar losses. 

Westpac strategists expect the US dollar to eventually find its feet.

"But over the next month, the Fed's dovish shift is likely to continue weigh on the greenback, posing upside risks for the USD/AUD," said the economists in a note. 

Capital Economics, meanwhile, said the Reserve Bank may try to talk the Aussie down when it meets next week.

"While the Reserve Bank of Australia will almost certainly leave interest rates at 2 per cent at the policy meeting on Tuesday April 5, it may try to give activity and inflation a boost by attempting to talk down the Australian dollar," said Capital economist Paul Dales. 

"In any case, we believe that the dollar will weaken later this year as subdued economic growth and low underlying inflation prompt the Reserve Bank to cut rates again." 

A quiet week for domestic Australian data means investors will remain focused on US economic indicators, particularly April Fool's Super Friday, where US jobs data will be the headline event.

Despite weaker oil prices and poor performance by Australian banks, the Aussie dollar was elevated before Yellen's speech. Indeed, less than stellar property news out of China also should have theoretically placed downward pressure on the currency.  

Greg Gibbs, founder of AmpGFX Capital, suggests the Aussie's strength, as well as the New Zealand dollar's strength, could be a result of a return to carry trades - a strategy where investors borrow in a low interest rate currency then convert it into another currency, with higher interest rates. 

"What may be happening is a return to carry trades and demand for higher yielders funded out of the negative yielding JPY in particular that has been grinding weaker over the last two weeks," said Mr Gibbs. 

Japan's recent foray into negative interest rate territory has investors hungry for yield opportunities. 

"If the move is being driven by Japanese investors, they are likely to prefer the NZD since it is coming off a recent base vs. the JPY, as Japanese investors much prefer to buy around recent lows than chase a rising market," Mr Gibbs added.