Australian Dollar Outlook: Central Banks Continue to Grapple with CPI

The Australian Dollar finished the second quarter not far from where it started after breaking both sides of an established range. Although some domestic factors haver played a role in AUD/USD direction, the US Dollar remains a dominant factor for the currency.

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The RBA and the Fed have their say

The 0.6565 – 0.6900 range played out from February through to late May before the dip lower on the back of a stronger USD. Early June saw the RBA surprise markets with a 25 basis point hike and AUD/USD rallied in the aftermath. Interest rate futures are pricing two more lifts in the cash rate target by the end of the year from the RBA.

US Federal Reserve Chair Jerome Powell has reaffirmed the bank’s hawkish stance after a pause in its hiking cycle at the last Federal Open Market Committee (FOMC) meeting in mid-June. The decision not to raise rates saw the US Dollar initially undermined but then subsequently strengthen on Powell’s comments. The Fed’s next meeting in late July might provide some impetus for the next significant move in the Aussie Dollar.

Commodity Prices Add to Trade Surplus

The fundamental backdrop for the Australian economy remains strong but it may not contribute to a higher exchange rate. The trade surplus continues to significantly contribute to bottom line with many of Australia’s key commodity exports in global demand.

Chart prepared by Dan McCarthy, created with TradingView

Bond Spread Correlation

The correlation of the bond spreads to AUD/USD is sometimes high, but not always so. However, it is certainly worth tracking to look for clues in the currency’s directions.

June also saw the Australian 3s 10s government bond yield invert for the first time since 2008. When this occurs, the implication from the bond market is that an economic slowdown is possible at some stage further down the track.

Chart prepared by Dan McCarthy, created with TradingView

Australian CPI Might Hold the Key

Going into the third quarter, a key piece of economic data will be Australia’s quarterly CPI figures that will be released on July 26th. Another hot number there may see the RBA tilt back toward a more aggressive tightening stance. A soft reading might see the opposite unfold. Nonetheless, AUD/USD could see some volatility if CPI is dramatically different from expectations.

The actions of the RBA and Fed appear likely to be a driving factor for the currency going forward. A problem for markets, and the banks themselves, is the uncertainty around the rate path in the months ahead. Both banks have made it clear that the upcoming decisions will be depending on the data as it is released, which makes it difficult to anticipate AUD/USD moves.