March lows in focus as Australian Dollar retreats on diverging Fed and RBA outlooks

March lows remain in focus for AUD/USD as expectations for Fed and RBA policy pull apart.
The US Dollar approaches its annual high, supported by above-forecast US inflation and hawkish Fed comments.
Following its fifth rate increase this year, the RBA tones down guidance on additional tightening.

AUD/USD trades around 0.6846 at the time of writing. The pair is down 0.28% on the day and remains under pressure on Wednesday, close to levels last recorded in March. Weighing on the Australian Dollar (AUD) are growing expectations that monetary policy at the Federal Reserve (Fed) and the Reserve Bank of Australia (RBA) could diverge over the coming months.

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

Demand for the Greenback has strengthened as above-forecast US consumer inflation and hawkish comments from Fed officials reinforce expectations of more aggressive rate increases. Tracking the US Dollar against six major currencies, the US Dollar Index (DXY) advances 0.68% on the day. It is extending its rally into a second consecutive day and nearing the year-to-date peak of 102.94 recorded in October.

October’s US Consumer Price Index (CPI) increased 0.4% MoM, exceeding the 0.3% forecast while slowing from September’s 0.6%. Excluding food and energy, core CPI climbed 0.3%. That matched September’s increase and surpassed expectations of 0.2%.

December rate hike expectations strengthen as Fed hawks speak and political concerns recede

For Rabobank analysts, the reaction to “the hawkish commentary from Fed officials yesterday, including those from Waller that put the risk of a 50-bps rate hike on the table, says more than just the obvious.” Their assessment is that “the market is now fully priced for a December rate hike,” with particular importance attached to the comments being received “with no real speculation that the Fed would be pressured by political forces not to raise rates,” indicating less attention to the risk of political interference in Fed policy.

Support for additional monetary tightening also came from Dallas Fed President Lorie Logan and Philadelphia Fed President Anna Paulson. Meanwhile, Fed Vice Chair for Supervision Michelle Bowman emphasised the need to get inflation under control.

In Australia, an expected 25 basis points (bps) increase at the RBA’s November meeting brought the cash rate to 4.85%, lifting borrowing costs to their highest since 2008. This was the fifth increase this year, with policymakers confronting inflation driven by higher Oil prices. However, the RBA moderated its guidance by removing an explicit reference to further increases if required. As Governor Michele Bullock put it, it was “probably best to pause and assess incoming data.”

According to OCBC analysts, the “market has started to price in some chance of easing towards the latter part of 2027,” and cash rate futures “last priced a 74% chance of a 25bp cut by December 2027.” Reflecting that repricing, OCBC maintains its base case “for a 25bp cut in 4Q2027.”

RBA: key questions answered

Reserve Bank of Australia: its role and influence on the Australian Dollar

Australia’s interest rates and monetary policy are set by the Reserve Bank of Australia (RBA). A board of governors takes decisions at 11 scheduled meetings each year, supplemented by emergency meetings when necessary. Price stability is its primary mandate, defined as inflation of 2-3%. Its remit is also “..to contribute to the stability of the currency, full employment, and the economic prosperity and welfare of the Australian people.” Raising or cutting interest rates is the RBA’s principal means of meeting these objectives. Relatively high rates strengthen the Australian Dollar (AUD), while the reverse also applies. Quantitative easing and quantitative tightening are among its other policy tools.

Inflation data and its effect on the Australian Dollar

Traditionally, inflation was regarded as detrimental to currencies because it erodes the value of money. With cross-border capital controls relaxed in modern times, however, the relationship has reversed. Moderately higher inflation now typically prompts central banks to raise interest rates. Higher rates attract capital from global investors looking for attractive returns, lifting demand for the domestic currency. In Australia, that currency is the Australian Dollar.

Economic indicators and their influence on the Australian Dollar

By measuring an economy’s health, macroeconomic releases can affect its currency’s value. Investors favour stable, expanding economies over those that are fragile and contracting. Larger capital inflows boost overall demand for the domestic currency and raise its value. GDP, Manufacturing and Services PMIs, employment figures and consumer sentiment surveys are among the established indicators that can move AUD. Economic strength may also prompt the Reserve Bank of Australia to raise interest rates, providing further support for AUD.

Quantitative Easing (QE): implications for the Australian Dollar

When interest rate cuts alone cannot restore credit flows, Quantitative Easing (QE) offers a policy tool for extreme conditions. Under QE, the Reserve Bank of Australia (RBA) prints Australian Dollars (AUD) to purchase assets from financial institutions. These assets are generally government or corporate bonds, and the purchases supply institutions with much-needed liquidity. A weaker AUD is the usual outcome.

Quantitative tightening (QT): implications for the Australian Dollar

Once economic recovery is under way and inflation begins to rise, quantitative tightening (QT) reverses the earlier QE process. During QE, the Reserve Bank of Australia (RBA) supplies liquidity to financial institutions by purchasing government and corporate bonds. Under QT, it ceases additional asset purchases and no longer reinvests the principal from maturing bonds in its existing holdings. This would support the Australian Dollar, making it a bullish factor for the currency.