Fed rate cut speculation pushes the Aussie dollar to a 3-week high

• The AUD/USD rose to a three-week high on Monday.

• Weak economic data and dovish commentary from a senior US Federal Reserve member saw US bond yields tumble, dragging the greenback lower. Markets are now pricing in two 25 basis point Fed rate cuts this year.

• The RBA will almost certainly cut Australia's cash rate for the first time since August 2016 on Tuesday. RBA Governor Philip Lowe will also speak later in the session. It's also a big economic data day in Australia.

• US Federal Reserve Chair Jerome Powell will speak today. John Williams, New York Fed President, will also be in action. These speeches could prove to be pivotal on the outlook for US interest rates.

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The Australian dollar hit a three-week high against the greenback on Monday, propelled higher by growing expectations that the US Federal Reserve will cut official interest rates this year, potentially as soon as next month.

The Aussie's rally came despite widespread expectations that the Reserve Bank of Australia (RBA) will cut Australia's cash rate for the first time since August 2016 on Tuesday.

Here's the Aussie dollar scoreboard at 7am in Sydney. Data provided by Refinitiv.

AUD/USD 0.6976 , 0.0038 , 0.55%
AUD/JPY 75.38 , 0.20 , 0.27%
AUD/CNH 4.8284 , 0.0224 , 0.47%
AUD/EUR 0.6205 , 0.0001 , 0.02%
AUD/GBP 0.5508 , 0.0021 , 0.38%
AUD/NZD 1.0570 , -0.0009 , -0.09%
AUD/CAD 0.9378 , 0.0006 , 0.06%

As was the case on Friday, the main theme of Monday's trading session was US dollar weakness, driven by a combination of dovish commentary from a senior US Federal Reserve FOMC member and increased concern about the US economic outlook.

"James Bullard from the St. Louis Fed said a rate cut 'may be warranted soon to help re-centre inflation and inflation expectations at target and also to provide some insurance in case of a sharper-than-expected slowdown'," said Ray Attrill, Head of FX Strategy at the National Australia Bank.

"Bullard is a current FOMC voter, so it will be noteworthy how he votes at upcoming Fed meetings."

Along with the first public acknowledgment that the Fed funds rate may be cut soon, the dollar was also undermined by a series of weak US manufacturing PMI reports released during the session.

The ISM's manufacturing PMI fell to 52.1 in May from 52.8 in April, leaving it at the lowest level since 2016. The separate IHS Markit US manufacturing PMI fared even worse, declining to levels not seen for a decade.

Combined, weak data and Bullard's remarks saw US bond yields continue to tumble, reflecting growing expectations of Fed rate cuts in the months ahead.

"10-year Treasury yields are down another five basis points to 2.07%. A month ago those were above 2.60%. Two-year yields are down a bigger eight basis points to 1.84% as Fed easing expectations actions ratchet up," said Attrill at the NAB

"Fed Funds markets meanwhile have again moved the dial on easing expectations, with two 25-point cuts fully priced before the end of this year and half a chance of a third, with a full 100 basis points priced by September 2020."

The sharp decline in US bond yields weighed on the greenback as a consequence, helping the Aussie dollar to climb to the highest level since May 13.

Image: Investing.com

Turning to the day ahead, it will be a busy one for traders with the RBA interest rate decision, a speech from RBA Governor Philip Lowe, and a raft of domestic economic to digest.

For the RBA decision at 2.30pm AEST, financial markets and almost every economist expects the bank will cut Australia's cash rate to 1.25% today.

Here's a 10-second guide on what to look out for in the accompanying statement. TD Securities has also taken a look at how financial markets may react depending on what the RBA has to say.

Before the RBA takes centre stage, markets will receive Australian retail sales data for April along with net exports and government demand figure for the March quarter, two large components in Australian GDP.

This guide looks at what the retail sales report is likely to contain. All three releases arrive at 11.30am AEST.

Rounding off the busy domestic calendar, RBA Governor Philip Lowe will also speak at 7.30pm AEST.

Presuming the RBA cuts rates, Lowe will likely use this opportunity to explain the rationale behind the decision. He may also provide clues as to whether or not the bank will look to ease policy settings further in the months ahead, something both economists and markets expect.

Outside of Australia, other data highlights today include Eurozone inflation along with the Empire State manufacturing index and factory orders from the United States.

In what could prove to be a pivotal moment for US rate cut expectations, US Federal Reserve Chair Jerome Powell will also speak from 11.45pm AEST. John Williams, the New York Fed President, will also deliver a speech from 10.30pm AEST.

Of all events in the second half of the session, these speeches carry the greatest potential to generate short-term volatility in currency markets.