THE Australian dollar followed equity markets lower in Asia yesterday in thin trade as currency and bond traders squared up positions ahead of crucial inflation numbers.
Before that, US earnings and continuing record supply of treasurys will provide some market direction but the main focus is on today's inflation numbers, which will guide the Reserve Bank at next week's policy meeting.
Danica Hampton, currency strategist at the Bank of New Zealand, said more steam could be sucked out of the dollar if inflation was weaker than expected.
"The risk is if we see a benign inflation number we'll get a greater pullback as everyone has been so bullish on the Aussie over the past couple of months and ultimately very hawkish on the RBA," she said.
Economists expect core inflation to rise 0.7 per cent for the quarter and 3.4 per cent for the year. At 5pm, the dollar was trading at US91.89c, down from US92.37c late on Monday.
Against the yen, it was trading at Y84.63, down from Y84.835. Adding support to the local unit was market chatter about Asian sovereigns and quasi sovereigns buying the dollar, Ms Hampton said.
Barclays Capital strategist David Forrester said the dollar was undervalued against Barclay's financial fair value model, meaning it had scope to rise and should test parity in coming months.
"There is no extreme deviation from our financial fair value estimate at the moment but the undervaluation of (the Australian dollar against US dollar) has been widening, suggesting that the strong Australian dollar is well supported by fundamentals and not yet overstretched, which is in line with our medium-term outlook for the Australian dollar going towards parity in six months."
Bonds drifted higher in light trade but there was little to guide ahead of the inflation numbers, JPMorgan rates senior strategist Sally Auld said.
"Everyone is waiting for tomorrow," she said.
December three-year bonds were up four ticks at 94.61, while 10-year bonds were 2.5 ticks higher at 94.28.
