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Summary: After a significant decline last week, the Australian dollar started a strong adjustment. During the European session, the AUDUSD pair surpassed the 0.6700 level, gaining 1%.

Fundamentals

Australia's July TD-MI Inflation Gauge rose by 0.8% in July, rebounding significantly from 0.1% in June, surpassing the market's general expectation of 0.5%. Considering last week's inflation report showed a notable slowdown in inflation, this rise came as somewhat surprising. After the news was released, the Australian dollar surged.

The Reserve Bank of Australia (RBA) will hold a meeting this week, and it is expected to keep the cash rate unchanged at 4.10%. The past two rate gatherings were on a knife's edge, and Tuesday's meeting could be no different. However, according to data from the Australian Securities Exchange (ASX) RBA Rate Tracker, the currency market is fully pricing in a pause in rate hikes, with only a 14% probability of an increase.

Such pricing seems fair. As inflation cools off and business confidence deteriorates, the RBA appears not to be in a real hurry to press the rate hike button again. However, the RBA may adopt a relatively hawkish tone to keep the prospect of future action open. As the labor market remains tight, there are concerns that wage pressures could intensify, keeping the inflation fire burning for a while.

If the RBA chooses to hike, it might catch the market by surprise. This is because China has launched a robust stimulus plan, which could pose a risk of re-emergence of inflation. As for the Australian dollar, the most critical variable may be the strength and scope of China's stimulus measures, rather than domestic developments.

Considering everything, the wisest move for the RBA might be to keep rates unchanged but signal that the tightening cycle is not over. Such a policy could bring volatility to the market, and if rates stay unchanged, the initial reaction of the Australian dollar could be negative. However, if the RBA adopts a hawkish tone, any weakness could be short-lived and even reversed.

Technical Analysis

After a significant drop last week, the AUDUSD is currently in a strong recovery mode. Bulls seem to have found support around 0.6622, fostering optimism for the possibility of the next bull market happening soon.

One reason behind this optimism might be the market's continued anticipation of an unexpected rate hike by the RBA, similar to what happened before. However, as we mentioned earlier, times have changed. The market might be in for a substantial pullback after this rally, just as we described in our previous strategy (where subsequent movements may remain bearish if the price falls below 0.6648).

From a technical standpoint, as the RSI avoids falling below the neutral-50 level, the currency pair might regain some additional ground in the short term and subsequently moderate-higher. However, the stochastic oscillator has not changed its upward direction. Meanwhile, after the significant price drop last week, a "double top" pattern has formed, indicating potential further downside.

Nevertheless, investors should maintain a certain level of caution, as the challenging descending trendline since April 2022 around 0.6860 could delay the struggle for the 0.6900 level. If buying interest drives the price above the latter, the focus will shift to the resistance line connecting the April and June highs at 0.6965. A breakthrough of this barrier could lead bulls to make a slight adjustment near 0.7030 before targeting the 2023 peak at 0.7157.

Overall, we still believe that the current rebound is unlikely to trigger a trend reversal unless there is a comprehensive break above 0.7160. In terms of trading strategy, it is recommended to focus on going short at highs.

Trading Recommendations

Trading Direction: Short

Entry Price: 0.6750

Target Price: 0.6494

Stop Loss: 0.6900

Valid Until: 2023-08-14 23:55:00

Support: 0.6716, 0.6622, 0.6594

Resistance: 0.6753, 0.6821, 0.6847