AUD/USD softens as markets digest US inflation data

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The Australian Dollar (AUD) trades on the back foot against the US Dollar (USD) on Tuesday, pressured by a firmer Greenback following the release of the latest US inflation figures. At the time of writing, AUD/USD trades around 0.6677, retracing all of the previous day’s gains.

AUD/USD slips as US CPI data temper expectations for near-term Fed rate cuts.
US headline inflation met forecasts, while core CPI softened modestly.
Cautious Fed expectations and weak Australian Consumer Sentiment weigh on the Aussie.

Data released by the US Bureau of Labor Statistics showed that the Consumer Price Index (CPI) rose 0.3% MoM in December, matching market expectations and unchanged from November. On an annual basis, headline inflation held steady at 2.7%, also in line with forecasts.

Meanwhile, core CPI, which excludes volatile food and energy components, increased 0.2% MoM, coming in below expectations of 0.3% and matching the previous month’s reading. On a yearly basis, core inflation stood at 2.6%, undershooting the 2.7% market forecast and unchanged from November.

From a monetary policy perspective, the data suggest inflation is moderating only gradually, as it remains above the Federal Reserve’s (Fed) 2% target. This backdrop has tempered expectations for near-term rate cuts, reinforcing the view that the central bank will stick to a cautious easing path.

Markets continue to price in around two Fed rate cuts later this year, while widely expecting policymakers to keep interest rates unchanged at the January 27-28 meeting.

Additional support for the US Dollar came from remarks by St. Louis Fed President Alberto Musalem, who said inflation remains "closer to 3% than 2%" but expects it to ebb this year as the labour market cools in an "orderly" way. Musalem warned that the risk of inflation persistence is "still with us," arguing there is "little reason for further easing of policy in the near term."

At the same time, he noted that a materialisation of job-market risks or a faster-than-expected decline in inflation could make additional rate cuts appropriate.

In Australia, data released earlier on Tuesday showed Westpac Consumer Confidence fell 1.7% in January, after plunging 9% in December, offering little support to the Aussie.

Looking ahead, attention turns to US economic releases on Wednesday, including Retail Sales and the Producer Price Index (PPI). Markets will also monitor comments from several Fed officials for additional guidance on the monetary policy outlook.

Australian Dollar FAQs

What key factors drive the Australian Dollar?

One of the most significant factors for the Australian Dollar (AUD) is the level of interest rates set by the Reserve Bank of Australia (RBA). Because Australia is a resource-rich country another key driver is the price of its biggest export, Iron Ore. The health of the Chinese economy, its largest trading partner, is a factor, as well as inflation in Australia, its growth rate and Trade Balance. Market sentiment – whether investors are taking on more risky assets (risk-on) or seeking safe-havens (risk-off) – is also a factor, with risk-on positive for AUD.

How do the decisions of the Reserve Bank of Australia impact the Australian Dollar?

The Reserve Bank of Australia (RBA) influences the Australian Dollar (AUD) by setting the level of interest rates that Australian banks can lend to each other. This influences the level of interest rates in the economy as a whole. The main goal of the RBA is to maintain a stable inflation rate of 2-3% by adjusting interest rates up or down. Relatively high interest rates compared to other major central banks support the AUD, and the opposite for relatively low. The RBA can also use quantitative easing and tightening to influence credit conditions, with the former AUD-negative and the latter AUD-positive.

How does the health of the Chinese Economy impact the Australian Dollar?

China is Australia’s largest trading partner so the health of the Chinese economy is a major influence on the value of the Australian Dollar (AUD). When the Chinese economy is doing well it purchases more raw materials, goods and services from Australia, lifting demand for the AUD, and pushing up its value. The opposite is the case when the Chinese economy is not growing as fast as expected. Positive or negative surprises in Chinese growth data, therefore, often have a direct impact on the Australian Dollar and its pairs.

How does the price of Iron Ore impact the Australian Dollar?

Iron Ore is Australia’s largest export, accounting for $118 billion a year according to data from 2021, with China as its primary destination. The price of Iron Ore, therefore, can be a driver of the Australian Dollar. Generally, if the price of Iron Ore rises, AUD also goes up, as aggregate demand for the currency increases. The opposite is the case if the price of Iron Ore falls. Higher Iron Ore prices also tend to result in a greater likelihood of a positive Trade Balance for Australia, which is also positive of the AUD.

How does the Trade Balance impact the Australian Dollar?

The Trade Balance, which is the difference between what a country earns from its exports versus what it pays for its imports, is another factor that can influence the value of the Australian Dollar. If Australia produces highly sought after exports, then its currency will gain in value purely from the surplus demand created from foreign buyers seeking to purchase its exports versus what it spends to purchase imports. Therefore, a positive net Trade Balance strengthens the AUD, with the opposite effect if the Trade Balance is negative.

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