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AUD/USD nears six-month high near 0.6750 on firm Fed rate cut outlook

  • AUD/USD holds gains near a six-month high around 0.6750 as traders increase Fed rate cut bets.
  • The strength of the US labor market appears to have lost momentum.
  • The RBA could tighten monetary policy further.

The AUD/USD pair is trading near a six-month high of 0.6760 in Monday’s New York session. The Australian asset is holding onto gains while the US Dollar (USD) is on the defensive due to growing speculation that the Federal Reserve (Fed) will start cutting interest rates from the September meeting.

Traders are increasing bets on Fed rate cuts in September as the strength of the US labour market appears to be moderating. The Non-Farm Payrolls (NFP) report for June showed that the unemployment rate rose to 4.15 in more than two years. Moreover, average hourly earnings, a measure of wage growth, have declined as expected, reducing risks of inflation remaining persistent.

Increased expectations for early Fed rate cuts have improved market sentiment. S&P 500 futures have recovered losses recorded earlier in Europe and turned positive. The US Dollar Index (DXY), which tracks the value of the greenback against six major currencies, has fallen to a near three-week low around 104.85.

Contrary to market expectations, Fed officials signaled in their latest dot plot that there will be only one rate cut this year. Looking ahead, the main trigger will be the US Consumer Price Index (CPI) report for June, due out on Thursday. US inflation will influence market expectations for Fed rate cuts in September.

On the Australian front, rising expectations that the Reserve Bank of Australia (RBA) could tighten policy further have kept the Australian Dollar (AUD) strong. Upside risks to price pressures have boosted bets for more rate hikes from the RBA.

Being a proxy player for the world’s second-largest economy, the Australian dollar will be impacted by China’s CPI report for June, due out on Wednesday. The report is expected to show that price pressures grew at a higher pace of 0.4% from the previous release of 0.3% year-on-year.

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 compared to 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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