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AUD/USD consolidates near 0.6750 as investors await US inflation

  • AUD/USD trades sideways with US inflation in focus.
  • Fed’s Powell cited concerns about waning strength in the U.S. labor market.
  • The RBA is expected to keep interest rates unchanged throughout the year.

The AUD/USD pair remains in a tight range near 0.6750 in the European session on Wednesday. The Australian asset is moving sideways as investors have remained on the sidelines with the focus on the United States (US) Consumer Price Index (CPI) data for June, due out on Thursday.

Inflation data will provide clues as to when the Federal Reserve (Fed) will start cutting interest rates. Meanwhile, market sentiment remains firm as investors view a Fed rate cut at the September meeting as a given due to the easing US labor market conditions. S&P 500 futures have posted some gains in European trading hours. The Dollar Index (DXY), which tracks the value of the greenback against six major currencies, remains near 105.00.

On Tuesday, Fed Chairman Jerome Powell said in semiannual testimony before Congress that escalating inflation has not been the only risk to the Fed’s dual mandate. Powell warned of waning strength in the U.S. labor market as the U.S. is no longer an overheated economy.

The latest US Nonfarm Payrolls data also showed a downward trend in job demand, a rise in the unemployment rate to its highest level in more than two years and an expected slowdown in average hourly earnings, a measure of wage growth.

On the Australian front, growing speculation that the Reserve Bank of Australia (RBA) will be the latest to join the global rate-cutting cycle has kept the Australian Dollar (AUD) in a favourable position. The RBA is expected to keep its Official Cash Rate (OCR) at its current levels throughout the year due to the reversal of disinflation, driven by strong consumer spending.

Australian Dollar FAQs

One of the most important factors for the Australian Dollar (AUD) is the level of interest rates set by the Reserve Bank of Australia (RBA). Since Australia is a resource-rich country, another key factor is the price of its largest export, iron ore. The health of the Chinese economy, its largest trading partner, is a factor, as is inflation in Australia, its growth rate and the Trade Balance. Market sentiment, i.e. whether investors are betting on riskier assets (risk-on) or seeking safe havens (risk-off), is also a factor, with risk-on being positive for the AUD.

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 RBA’s main objective 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 ones. The RBA can also use quantitative easing and tightening to influence credit conditions, with the former being negative for the AUD and the latter positive for the AUD.

China is Australia’s largest trading partner, so the health of the Chinese economy greatly influences the value of the Australian Dollar (AUD). When the Chinese economy is doing well, it buys more raw materials, goods and services from Australia, which increases demand for the AUD and drives up its value. The opposite occurs when the Chinese economy is not growing as fast as expected. Therefore, positive or negative surprises in Chinese growth data often have a direct impact on the Australian Dollar.

Iron ore is Australia’s largest export, worth $118 billion per year as of 2021 data, with China being its main destination. The price of iron ore can therefore be a driver of the Australian dollar. Typically, if the price of iron ore rises, the AUD rises as well, as aggregate demand for the currency increases. The opposite occurs when the price of iron ore falls. Higher iron ore prices also tend to lead to a higher probability of a positive trade balance for Australia, which is also positive for the AUD.

The trade balance, which is the difference between what a country earns from its exports and 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, its currency will gain value solely because of the excess demand created by foreign buyers wanting to purchase its exports versus what it spends on buying imports. Therefore, a positive net trade balance strengthens the AUD, with the opposite effect if the trade balance is negative.

Source: Fx Street

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