0.7050: Australian Dollar stays above level as hot CPI strengthens RBA rate hike bets

  • 0.40% gain for AUD/USD follows the Fed’s decision to leave interest rates unchanged.
  • 3.7% Australian trimmed mean CPI reinforces expectations of additional RBA tightening.
  • 85% probability of a December Fed rate hike precedes US PCE and GDP releases.

AUD/USD gains 0.40% on Wednesday. The advance follows the Federal Reserve’s decision to keep rates unchanged, with the pair trading at 0.7053. Fed Chair Kevin Warsh signalled that “officials had made clear our readiness to act as circumstances require, and we have shown our willingness to act.”

TMGM Analysis: Financial Market News, Economic Calendar & Market Insights

November tightening case lifts AUD/USD as Australian inflation offsets Warsh’s hawkish tone

Markets absorbed the Fed’s rate decision and Warsh’s comments without disruption as the week’s main event concluded. A hold had been anticipated in money markets. During the press conference, Warsh reiterated the committee’s resolve to bring inflation back to the Fed’s 2% target.

Although Warsh said policy tightening was taking effect, he stopped short of describing financial conditions as tight. Rejecting the idea of a “soft inflation target”, he confirmed that the price stability objective is 2%, measured by Personal Consumption Expenditures (PCE).

In its earlier monetary policy statement, the Fed acknowledged robust economic activity and said labour market gains “have kept pace with the workforce,”. It also noted elevated inflation but said further data would be needed to determine the appropriate policy stance.

There were no other scheduled releases beyond the Fed decision. According to Prime Terminal, swaps pricing assigned an 85% probability to a 0.25% rate increase in December.

Fed rate probabilities | Source: Prime Terminal

September’s Australian Trimmed Mean CPI increased by 3.7% YoY, compared with 3.5% previously, reinforcing the argument for a further rate rise. Following the release, Reserve Bank of Australia (RBA) Deputy Governor Hauser said that “inflation is too high.”

A November rate increase of 25 basis points is expected by ANZ analysts. In a note, they also said they “expect to see upward revisions to the RBA’s inflation forecasts which will be published in the November SMP.”

US data dominate the calendar

Australia has no scheduled releases. By contrast, a full US calendar includes Core PCE, the Fed’s preferred inflation gauge, alongside Gross Domestic Product (GDP) data and jobless claims.

AUD/USD Price Forecast: Technical assessment

Daily price chart: AUD/USD

Australian Dollar: Key Questions

Interest rates set by the Reserve Bank of Australia (RBA) are a major influence on the Australian Dollar (AUD). Australia’s abundant resources also make the price of iron ore, its largest export, an important driver. Other influences include conditions in China, Australia’s biggest trading partner, as well as domestic inflation, economic growth and the trade balance. Investor appetite for risk matters too: demand for riskier assets, or risk-on sentiment, supports AUD, while a move towards safe havens is described as risk-off.

By setting the interest rate at which Australian banks lend to one another, the Reserve Bank of Australia (RBA) affects borrowing costs across the economy and, in turn, the Australian Dollar (AUD). Its primary objective is stable inflation of 2-3%, pursued through increases or cuts in interest rates. Rates that are relatively high compared with those of other major central banks support AUD; relatively low rates have the reverse effect. Credit conditions can also be adjusted through quantitative easing or tightening. Easing is negative for AUD, whereas tightening is positive.

As Australia’s largest trading partner, China has a substantial influence on the Australian Dollar (AUD). A strong Chinese economy buys more Australian raw materials, goods and services, increasing demand for AUD and lifting the currency’s value. Growth that falls short of expectations has the opposite effect. This relationship means that upside or downside surprises in Chinese growth figures often feed directly into the Australian Dollar and its currency pairs.

At $118 billion annually, according to 2021 data, iron ore is Australia’s biggest export, with most shipments destined for China. Its price can therefore influence the Australian Dollar. Rising iron ore prices generally lift AUD by increasing aggregate demand for the currency, while falling prices tend to have the reverse effect. More expensive iron ore also makes an Australian trade surplus more likely, providing further support for AUD.

Export earnings minus import payments make up a country’s trade balance, another influence on the Australian Dollar. Strong overseas demand for Australian exports can lift the currency when demand from foreign buyers exceeds Australia’s spending on imports. A positive net trade balance therefore strengthens AUD, while a negative balance has the reverse effect.