How to curb high inflation? A central bank can raise interest rates aggressively and then stop, as the Fed is willing to do. Or, one can make small steps for a longer period of time, as in the case with the RBA. How different approaches will affect the AUDUSD? Let’s discuss the topic and make up a trading plan.
Weekly Australian dollar fundamental analysis
Europe is trying to become independent from Russian oil and gas, and it seems to succeed. China imposes tariffs on Australia for promoting an inquiry into COVID-19. In late 2022, Australia has rebuilt its trade flows, which had a positive effect on the economy and kept the AUDUSD from a further decline.
By 2021 China accounted for 42% of Australia’s exports, and it has not been so dependent on one country since 1938 when it was a British colony, and by 2022, the share decreased to 29.5%. The last time the figure was less than 30% was in October 2015. Given the weakness of China’s economy due to the pandemic, the reorientation of Australia’s foreign trade supports the Australian dollar.
Still, the AUD trend continues to be determined by monetary policy. As the RBA raised the cash rate by a modest 25 basis points, and the Fed intends to add 75 basis points to the federal funds rate a day later, the AUDUSD downtrend should resume. However, things are not that simple.
Dynamics of Australia’s inflation and RBA interest rate
Source: Reuters.
In October, the Reserve Bank surprised investors with a quarter-point rate hike, ending a series of four meetings, at which the rate was raised by 50 basis points. At the same time, the highest inflation of 7.3% since 1990 made some analysts suggest that the monetary tightening pace could increase again. Nevertheless, Philip Lowe and his colleagues decided to move slowly to gain sustainable results. The cash rate increased by 25 basis points in November to 2.85%, the highest level since 2013. Furthermore, the central bank, in its updated forecasts, showed that inflation will peak not at 7.75% but at 8% by the end of 2022 and will not return within the target range of 2%-3% until the end of 2024.
In terms of monetary policy, this means that the RBA will take small steps. However, when the Fed stops, it will continue raising rates. This approach could support the AUDUSD bulls ahead of the Fed pause, which is expected by March 2023. In the meantime, the US-Australian bond yield spread continues to widen, putting pressure on the Aussie.
Dynamics of AUDUSD and US-Australia yield spread
Source: Bloomberg.
Weekly AUDUSD trading plan
In fact, nobody knows when the Fed will suspend monetary tightening. Investors have many times been mistaken when expecting the Fed to turn dovish, seeing the slower pace of raising the rates as a dovish shift. As a result, the AUDUSD exchange rate is determined by Jerome Powell. If the Fed President signals a slowdown in the rate-hiking cycling, one could buy the pair with targets of 0.656 and 0.663. Otherwise, providing the Fed proves its decisiveness, and the AUDUSD breaks out the support at 0.637, it will be relevant to sell the Aussie down to $0.628 and $0.62.
Price chart of AUDUSD in real time mode
The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteFinance. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.
