AUD/USD's recent rally has paused as the pair consolidates gains made since the June monthly low—a pattern that is technically bullish. However, far larger gains could materialize if the Federal Reserve fails to adopt the hawkish stance that markets

have recently priced in. Inflation-linked markets suggest the Fed may not need to be as hawkish as investors currently expect. U.S. 2-year and 5-year inflation breakevens have resumed declining from their late April/early May peaks, striking fresh trend lows, while 2-year and 5-year inflation-linked swaps have sunk, erasing nearly all the gains accumulated in July. If the Fed surprises investors by downplaying inflation concerns and signaling that price pressures are less worrisome, U.S. interest rates and the dollar could fall sharply.

Such dollar weakness could be amplified by positioning dynamics: CFTC data shows the net-long U.S. dollar position

is at its largest level in 11½ years, leaving considerable room for unwinding. At the same time, net-short Australian dollar positions are at their largest since early December, setting up potential short-covering.

The combination of these position adjustments alongside falling U.S. interest rates could push AUD/USD higher, allowing the pair to complete its current consolidation phase. If this scenario unfolds, AUD/USD could then challenge key resistance in the 0.7150 to 0.7200 region, marking a significant technical and directional shift for the currency pair.
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(Christopher Romano is a Reuters market analyst. The views expressed are his own)