AUD/USD tumbles as RBA-Fed outlook widens

AUD/USD is holding around 0.6970 as hotter-than-expected U.S. inflation contrasts with weaker Australian jobs data.

AUD is falling on Thursday to a two-week low and remains near its recent 13-week low of 0.69 after a surprisingly weak jobs report caused investors to rein in expectations of another RBA rate hike.

Aussie jobs data slams RBA rate hike expectations

Australian employment fell by 39,300 in September, marking the largest decline since early last year and going against expectations for a rise of 20,000. Meanwhile, the unemployment rate remained at a five-year high of 4.7%, with August revised higher from an initial 4.6%. The RBA had not expected unemployment to reach 4.7% until the end of next year.

In reaction to the data, the market has reined in the chances of a November rate hike to just 9%, down from 32% before the release. Expectations for a December hike have fallen to 28% from 56%.

The RBA has already raised rates by 100 basis points this year to 4.6% as it attempts to cool sticky inflation, and the central bank has left the door open to further tightening if required. However, the deterioration in the labour market should give the RBA more confidence that monetary policy is restrictive, particularly given that the full impact of previous tightening has yet to be felt. This means we could see the labour market deteriorate further as the effects of tighter monetary policy work their way through the economy.

The market still sees 17 basis points of hikes before May next year. However, this is significantly lower than the 75 basis points of tightening expected from the Federal Reserve over the same period.

This divergence in rate expectations is becoming more bearish for AUD/USD, with markets scaling back expectations for further RBA tightening while continuing to price in a more hawkish Fed outlook. This could leave the pair vulnerable to further downside, particularly if upcoming U.S. data continues to point to persistent inflationary pressures.

The scaling back of RBA rate hike expectations is in sharp contrast to the market's reaction to hotter U.S. CPI data.

US inflation fuels Fed rate hike expectations

U.S. inflation climbed to 3.7% YoY, up from 3.4% in August, partly fuelled by higher fuel and energy prices. Gasoline prices jumped 9.1%. Meanwhile, core inflation, which excludes more volatile items such as food and fuel, also accelerated more than expected to 2.6%.

The data showed that inflation was relatively broad-based, with everything from recreation and medical care to clothing becoming more expensive. This indicates that while higher energy prices are adding to the rise in headline inflation, underlying price pressures remain a concern for the Fed.

Following the data, the market ramped up October rate hike expectations from 19% to 45%, before easing back to 30%. Expectations for a December rate hike remain elevated at 87%. The data lifted Treasury yields and the U.S. dollar, which briefly spiked to a fresh 18-month high of 102.94 against a basket of currencies.

Now, the U.S. dollar is retreating from this 18-month peak, amid a pullback in Treasury yields following comments from Fed officials that tempered expectations for an October rate hike despite the hot inflation data.

This pullback highlights the risk of chasing the dollar higher following the inflation surprise. While the divergence in RBA-Fed monetary policy expectations favours the U.S. dollar, a softer tone from Fed officials or weaker U.S. data could provide some relief for AUD/USD.

Attention will turn to U.S. PPI data due later today, alongside retail sales and a speech by Federal Reserve Chair Kevin Warsh, for further clues on the Fed's rate outlook. Stronger-than-expected data could reinforce expectations for further tightening and put renewed pressure on AUD/USD. Conversely, softer data could ease rate hike expectations and allow the pair to recover, even if Australian labour market conditions remain weak.

AUD/USD forecast – technical analysis

AUD/USD's recovery from the 0.69 low has run into resistance at the 200 EMA around 0.6980. The pair trades below its 20, 50 and 200 EMAs, which, combined with the RSI below 50, keeps sellers hopeful of further downside.

Should resistance at the 200 EMA continue to hold, sellers will look to test support around 0.6920 and 0.69, the October low, bringing 0.6865, the June low, into play. A break below 0.69 would reinforce the bearish outlook and suggest that sellers are gaining control, turning attention turns to 0.6835 the March low.

Should buyers manage to rise above 0.6980, the 200 EMA and the psychological level of 0.70, this would expose the 50 EMA at 0.7045, before attention turns to 0.7125 horizontal resistance. A sustained recovery above 0.70 would weaken the immediate bearish outlook and suggest that buyers are regaining some control.

For now, the balance of risks remains tilted to the downside.