- The AUD/USD pair is trading back and forth around the 0.6200 level as investors focus on the US ISM Manufacturing PMI data.
- The Fed has signaled fewer interest rate cuts for this year.
- RBA policymakers need to be confident that inflation will fall in line with their expectations before turning to lower interest rates.
The AUD/USD pair is trading sideways around the 0.6200 level in the North American session on Friday. The Australian pair is strengthening as investors await the US ISM Manufacturing Purchasing Managers’ Index (PMI) data for December, which will be published at 15:00 GMT.
Economists expect the manufacturing PMI to remain unchanged at 48.4, indicating that activities have contracted at a steady pace. Signs of weakness in factory activities would reinforce expectations that the Federal Reserve (Fed) will take a “slower and more cautious” approach to cutting interest rates this year.
In its latest dot chart, the Fed indicated fewer interest rate cuts this year as policymakers were optimistic about the U.S. economic outlook. For its next policy meeting on January 29, the Fed is expected to leave interest rates unchanged in a range of 4.25%-4.50%, according to the CME FedWatch tool.
Ahead of the US ISM Manufacturing PMI data, the US Dollar (USD) fell slightly. However, it is close to its highest level in more than two years, with the US Dollar Index (DXY) trading around 109.00.
Meanwhile, the Australian Dollar (AUD) is trading sideways as investors await the monthly Consumer Price Index (CPI) data for November, which will be released on Wednesday. The monthly CPI is estimated to have risen by 2.3%, faster than the previous release of 2.1%. Signs of accelerating price pressures could force the Reserve Bank of Australia (RBA) to delay plans to shift to interest rate cuts.
Reserve Bank of Australia Governor Michelle Bullock said on December 10 that the central bank does not need to see inflation return to the desired range to begin cutting the official cash rate (OCR). However, the board must be “confident” that price pressures will return to the central bank’s 2% target.
Frequently asked questions about the Australian dollar
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). Because Australia is a resource-rich country, another major driver is the price of its largest export, iron ore. The health of the Chinese economy, its largest trading partner, is one factor, as well as Australia’s inflation, growth rate and trade. balance. Market sentiment – whether investors are snapping up riskier assets (risk on) or looking for safe havens (risk off) – is also a factor, with risk appetite positive for 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 affects 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 Australian dollar, and relatively low ones do the opposite. The RBA can also use quantitative easing and tightening to influence credit conditions, with the former being AUD negative and the latter AUD positive.
China is Australia’s largest trading partner, so the health of the Chinese economy has a major impact on the value of the Australian Dollar (AUD). When the Chinese economy is performing well, it buys more raw materials, goods and services from Australia, which raises demand for the Australian dollar, raising its value. The opposite is the case when the Chinese economy does not grow as quickly as expected. Therefore, positive or negative surprises in Chinese growth data often have a direct impact on the Australian dollar and its crosses.
Iron ore is Australia’s largest export, representing $118 billion annually according to 2021 data, and China is its main destination. Therefore, the price of iron ore could be a driver of the Australian dollar. In general, if the price of iron ore rises, the Australian dollar also rises, as overall demand for the currency increases. The opposite is the case if the price of iron ore falls. Higher iron ore prices also tend to increase the likelihood of a positive trade balance for Australia, which is also positive for 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 affect the value of the Australian dollar. If Australia produces highly sought-after exports, its currency will gain value from the excess demand generated by foreign buyers seeking to buy its exports in exchange for what it spends to buy imports. Therefore, a positive net trade balance strengthens the Australian dollar, with the opposite effect if the trade balance is negative.