AUD/USD exhibits strength above 0.6800 with RBA policy decision under spotlight

AUD/USD strengthens above 0.6800 with RBA policy on the horizon.
The RBA is expected to leave interest rates unchanged on Tuesday.
The US Dollar recovers amid growing uncertainty over the Fed’s interest rate outlook.

The AUD/USD pair performs strongly above 0.6800 in Monday’s European session. The Aussie asset gains as the Australian Dollar (AUD) outperforms its major peers ahead of the Reserve Bank of Australia’s (RBA) monetary policy decision, which will be announced on Tuesday.

Traders expect the RBA to leave its Official Cash Rate (OCR) unchanged at 4.35%, with inflationary pressures remaining persistent and upbeat job growth. Therefore, investors will focus on fresh guidance on interest rates for the remainder of the year. Currently, financial market participants expect that the RBA will keep its OCR at its current levels by the year-end.

Meanwhile, the US Dollar (USD) bounces back amid growing doubts over the Federal Reserve’s (Fed) likely monetary policy action in its remaining two monetary policy meetings this year. The US Dollar Index (DXY), which tracks the Greenback’s value against six major currencies, rises to near 101.00.

According to the CME FedWatch tool, the Fed will cut interest rates further by a total of 75 basis points (bps) in the November and December meetings, suggesting that there will be at least one 50 bps interest rate cut decision. For November’s policy meeting, the likelihood of the Fed reducing interest rates by 50 bps to 4.25%-4.50% is close to 50%.

On the contrary, a strong majority of over 100 economists expect that the Fed will cut its interest rates by 25 bps in each of its monetary policy meetings in the remaining year, according to a Reuters poll.

In today’s session, investors will keenly focus on the preliminary United States (US) S&P Global PMI data for September, which will be published at 13:45 GMT, as it will provide fresh cues on the nation’s current economic health.

The report is expected to show that the Manufacturing PMI came in higher at 48.5 than August’s print of 47.9 but remains below the 50.0 threshold. In the same period, activities in the service sector are estimated to have grown at a slower pace to 55.2 from the former reading of 55.7.

Australian Dollar FAQs

What key factors drive the Australian Dollar?

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.

How do the decisions of the Reserve Bank of Australia impact the Australian Dollar?

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.

How does the health of the Chinese Economy impact the Australian Dollar?

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.

How does the price of Iron Ore impact the Australian Dollar?

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.

How does the Trade Balance impact the Australian Dollar?

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.

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