Today Markets Analysis: The Australian dollar has fallen to around $0.71, extending last week’s decline and reaching its lowest level in almost two weeks. A stronger US dollar following hotter-than-expected US inflation has increased expectations for Federal Reserve rate hikes, while rising oil prices and renewed hawkish signals from the Reserve Bank of Australia are also reshaping the outlook for Australian monetary policy.

US Inflation Strengthens Dollar

The latest US inflation data has strengthened expectations that the Federal Reserve could raise interest rates at its meeting next week.

Markets are now pricing an 86% probability of a US rate hike next week, while expectations for another increase later in the year have also risen.

The shift in rate expectations has supported the US dollar, creating additional pressure on the Australian dollar.

For AUD/USD, the key issue is increasingly the relative direction of US and Australian interest rates. Even if the Reserve Bank of Australia remains hawkish, a more aggressive Federal Reserve can narrow or reverse the interest-rate advantage that previously supported the Australian currency.

RBA Keeps Australian Rate Hike Expectations Elevated

Australia’s domestic policy outlook is also becoming more complicated.

Hawkish comments from the Reserve Bank of Australia, combined with higher energy prices, have pushed markets to price in approximately a 90% probability of an RBA rate hike later this month.

RBA Assistant Governor Sarah Hunter said last week that the central bank may need to raise rates again if inflation proves more persistent than expected.

This creates an unusual situation for the Australian dollar: both the Fed and RBA are becoming more hawkish, yet the US dollar is currently benefiting more strongly from the repricing.

Oil Prices Add Another Inflation Risk

Energy markets are providing another important source of uncertainty.

Brent crude has remained above $100 a barrel, with new Houthi strikes on Saudi Arabia and Iranian attacks on shipping in the Gulf adding to concerns over global supply.

The situation has been compounded by the closure of a key Saudi oil pipeline.

For Australia, higher oil prices can have mixed implications. Australia is a major commodity exporter, meaning stronger commodity prices can support national income and the Australian dollar. However, sustained energy inflation can also increase domestic inflation pressures and force the RBA to maintain restrictive monetary policy for longer.

The result is a more complicated relationship between commodities, inflation and the currency.

AUD/USD Faces a Policy-Divergence Test

The Australian dollar is therefore being pulled in several directions.

The immediate pressure remains on the Australian dollar because the US rate repricing has strengthened the dollar broadly.

However, Australia’s own rate expectations could limit the downside if the RBA becomes more aggressive than markets currently anticipate.

What Traders Are Watching Next

The next major catalysts for AUD/USD are likely to come from the interaction between US monetary policy, Australian inflation and global energy prices.

Traders will be watching:

• Further US inflation and economic data ahead of the Fed meeting.
• The Federal Reserve’s guidance on future rate increases.
• Australian inflation indicators and RBA communication.
• Developments in Middle East energy supply.
• Brent crude’s ability to remain above $100.
• Whether AUD/USD can stabilise around the $0.71 area.

The key question is whether Australia’s relatively hawkish monetary-policy outlook can offset the renewed strength of the US dollar.

Today Markets View

The Australian dollar’s decline is not simply a commodity story. The more important driver is the changing interest-rate landscape.

Both the Fed and RBA are becoming more cautious about persistent inflation, but the US dollar is currently benefiting from a sharper repricing of Fed policy. That leaves AUD/USD vulnerable despite Australia’s own prospects for another rate increase.

Louis Roche, Analyst at Today Markets, said:

“AUD/USD is facing a difficult combination of stronger US rate expectations and renewed geopolitical pressure on energy markets. The RBA may still have to raise rates, but if the Fed is moving in the same direction, Australia’s interest-rate advantage becomes much less powerful. For the Australian dollar, the next move will depend on whether domestic inflation proves persistent enough to justify a sustained RBA tightening cycle.”

Bottom Line

The Australian dollar is trading near $0.71, its lowest level in almost two weeks, as stronger US inflation drives renewed Fed rate-hike expectations.

The RBA is also facing pressure to tighten policy, with markets pricing roughly a 90% chance of a rate increase later this month.

For now, however, the stronger US dollar remains the dominant force. Meanwhile, Brent crude above $100 and escalating Middle East supply risks add another layer of uncertainty for inflation and monetary policy.

Analysis by Louis Roche, Analyst, Today Markets