The "USD smile" suggests that the USD's performance is tied to the economic cycle. In its early stages, as the Federal Reserve cuts rates, the USD typically weakens while other global economies experience better growth. As the cycle matures, with rising inflation and asset prices, the Fed hikes interest rates, boosting the USD. This cycle impacts the AUD, as Australia's economy is significantly influenced by commodity prices and global growth.
The current situation, however, is complicated by geopolitical tensions and the fast-paced advancements in AI technology, which are reshaping the global economic landscape. These factors contribute to the structural headwinds that temper the cyclical benefits for the AUD, preventing it from fully capitalising on the global economic cycle.
For now, we remain in an early economic cycle phase with significant structural shifts. This is cyclically favourable for the AUD, yet these positive trends are counterbalanced by the strong structural headwinds. Consequently, while the USD is experiencing a shallower version of its typical "smile," the AUD is also experiencing a slower, albeit upward movement.
Looking ahead, the key question remains whether we are in a late cycle with growing credit issues in US banks due to persistent inflation or an early cycle where the Fed is poised to cut rates further. This uncertainty surrounding when the credit cycle will turn is critical for global forex markets.
As Credit Agricole notes, the USD's trajectory is complicated, with risk aversion favouring the USD but a dovish Fed outlook eroding its relative rate advantage. Investors are closely watching developments, particularly any resolution in US-China trade tensions, which could shift the already delicate balance in market sentiments.
In summary, while the USD smile has made a comeback, its impact on the AUD is moderated by both cyclical dynamics and structural challenges. Observers expect a cautious upward bias for the AUD, but the path remains slow and fraught with global economic intricacies.