The AUD/USD pair rises sharply to near 0.6750 in Monday’s European session. The Aussie asset surges at US Dollar’ expense as the latter faces a sharp selling pressure, with investors focusing on the Federal Reserve’s (Fed) monetary policy meeting, which is scheduled for Wednesday. The US Dollar Index (DXY), which tracks the Greenback’s value against six major currencies, tumbles below 100.70.
The Fed is almost certain to start reducing interest rates but traders remain divided over the likely interest rate cut size. Softer-than-expected United States (US) Producer Price Index (PPI) data for August and persistent concerns over slowing labor market conditions have recently prompted market expectations for the Fed to reduce interest rates by 50 basis points (bps) to 4.75%-5.00%.
According to the CME FedWatch tool, the probability for the Fed reducing interest rates by 50 bps has increased sharply to 57% from 30% a week ago.
Fed jumbo rate cut prospects have also been prompted after the interview of Jon Faust, a recent senior adviser to Fed Chairman Jerome Powell, to Wall Street Journal (WSJ) in which he comments indicated that the central bank should start the policy-easing cycle with 50 bps now rather than in November or December as expected by some officials, with current rates remaining far from their ultimate destination.
In the Aussie region, the Australian Dollar (AUD) will be influenced by the Employment data for August, which will be published on Thursday. The Unemployment Rate is estimated to have remained steady at 4.2%. Fresh payrolls are expected to come in at 25.5K lower than the prior release of 58.2K.
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.
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.
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.
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.
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.