Australian Dollar slips toward March lows as Fed and RBA outlooks diverge
- AUD/USD trades near its lowest levels since March as Fed and RBA policy expectations diverge.
- Hotter-than-expected US inflation and hawkish Fed remarks lift the US Dollar toward its yearly high.
- The RBA softens its guidance on further hikes after raising rates for the fifth time this year.
AUD/USD remains on the back foot on Wednesday, hovering near levels last seen in March. The Australian Dollar (AUD) loses ground as expectations grow that the Federal Reserve (Fed) and the Reserve Bank of Australia (RBA) could take different monetary policy paths in the coming months. At the time of writing, AUD/USD trades around 0.6846, down 0.28% on the day.
Hawkish remarks from Fed officials and hotter-than-expected US consumer inflation data have fueled bets on more aggressive rate hikes, boosting demand for the Greenback. The US Dollar Index (DXY), which tracks the Greenback against a basket of six major currencies, rises 0.68% on the day, extending gains for a second straight day and approaching its year-to-date high of 102.94 set in October.
The US Consumer Price Index (CPI) rose 0.4% MoM in October, above the 0.3% forecast but down from 0.6% in September. Core CPI, which excludes food and energy, rose 0.3%, matching September’s pace and beating the 0.2% forecast.
Fed hawks firm up December hike expectations as political pressure fears fade
Analysts at Rabobank highlight that the market’s response to “the hawkish commentary from Fed officials yesterday, including those from Waller that put the risk of a 50-bps rate hike on the table, says more than just the obvious.” They note that “the market is now fully priced for a December rate hike,” and, crucially, that these remarks were absorbed “with no real speculation that the Fed would be pressured by political forces not to raise rates,” underscoring a reduced focus on potential political interference in the Fed’s policy path.
Other Fed officials, including Dallas Fed President Lorie Logan and Philadelphia Fed President Anna Paulson, also backed further monetary policy tightening, while Fed Vice Chair for Supervision Michelle Bowman stressed the need to bring inflation under control.
On the Australian side, the RBA raised its cash rate by 25 basis points (bps) to 4.85% at its November meeting, as expected, taking borrowing costs to their highest level since 2008. The move marked its fifth hike this year as policymakers grapple with inflation fuelled by higher Oil prices. The central bank softened its guidance, dropping an explicit reference to further hikes if needed. Governor Michele Bullock said it was “probably best to pause and assess incoming data.”
Analysts at OCBC note that the “market has started to price in some chance of easing towards the latter part of 2027,” with cash rate futures “last priced a 74% chance of a 25bp cut by December 2027.” In line with this repricing, OCBC reiterates that its base case is “for a 25bp cut in 4Q2027.”
RBA FAQs
The Reserve Bank of Australia (RBA) sets interest rates and manages monetary policy for Australia. Decisions are made by a board of governors at 11 meetings a year and ad hoc emergency meetings as required. The RBA’s primary mandate is to maintain price stability, which means an inflation rate of 2-3%, but also “..to contribute to the stability of the currency, full employment, and the economic prosperity and welfare of the Australian people.” Its main tool for achieving this is by raising or lowering interest rates. Relatively high interest rates will strengthen the Australian Dollar (AUD) and vice versa. Other RBA tools include quantitative easing and tightening.
While inflation had always traditionally been thought of as a negative factor for currencies since it lowers the value of money in general, the opposite has actually been the case in modern times with the relaxation of cross-border capital controls. Moderately higher inflation now tends to lead central banks to put up their interest rates, which in turn has the effect of attracting more capital inflows from global investors seeking a lucrative place to keep their money. This increases demand for the local currency, which in the case of Australia is the Aussie Dollar.
Macroeconomic data gauges the health of an economy and can have an impact on the value of its currency. Investors prefer to invest their capital in economies that are safe and growing rather than precarious and shrinking. Greater capital inflows increase the aggregate demand and value of the domestic currency. Classic indicators, such as GDP, Manufacturing and Services PMIs, employment, and consumer sentiment surveys can influence AUD. A strong economy may encourage the Reserve Bank of Australia to put up interest rates, also supporting AUD.
Quantitative Easing (QE) is a tool used in extreme situations when lowering interest rates is not enough to restore the flow of credit in the economy. QE is the process by which the Reserve Bank of Australia (RBA) prints Australian Dollars (AUD) for the purpose of buying assets – usually government or corporate bonds – from financial institutions, thereby providing them with much-needed liquidity. QE usually results in a weaker AUD.
Quantitative tightening (QT) is the reverse of QE. It is undertaken after QE when an economic recovery is underway and inflation starts rising. Whilst in QE the Reserve Bank of Australia (RBA) purchases government and corporate bonds from financial institutions to provide them with liquidity, in QT the RBA stops buying more assets, and stops reinvesting the principal maturing on the bonds it already holds. It would be positive (or bullish) for the Australian Dollar.
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