AUD/USD strengthens on hopes of narrowing Fed-RBA policy divergence

AUD/USD holds gains near a five-month high of around 0.6730 on firm hopes that the Fed-RBA policy divergence will be narrowed soon.
Weak US labor demand in the private sector and contraction in Services PMI have strengthened early Fed rate-cut hopes.
Reserved disinflation and robust Retail Sales growth have prompted RBA rate hike bets.

The AUD/USD pair trades close to a five-month high near 0.6730 in Thursday’s American session. The Aussie asset strengthens amid firm speculation that the policy divergence between the Federal Reserve (Fed) and the Reserve Bank of Australia (RBA) would narrow.

Investors expect the Fed to start reducing interest rates from the September meeting. According to the CME FedWatch tool, 30-day Federal Funds Futures pricing data shows that the probability of rate cuts in September has improved to 72.6% from 66% recorded a week ago. The data also shows that the Fed will cut interest rates twice this year, which has improved investors' risk appetite. S&P 500 futures have posted nominal gains in European trading hours.

Early Fed rate cut expectations have been prompted by deepening concerns over the United States' (US) economic strength. The economy appears to have lost momentum in the second quarter, as the ISM Services PMI contracted in June. The Services PMI, a measure of activities in the service sector, which accounts for two-thirds of the economy, declined below the 50.0 threshold to 48.8 from expectations of 52.5 and the prior release of 53.8.

Also, labor demand in the private sector unexpectedly declined in June, which raised concerns over US labor market strength. Weak US data has weighed heavily on the US Dollar (USD). The US Dollar Index (DXY) has declined to near 105.20.

On the contrary, financial markets expect that the Reserve Bank of Australia (RBA) could tighten its policy further. Reversed disinflation and stronger-than-expected monthly Retail Sales have boosted the possibility of more rate hikes by the RBA. This has also strengthened the Australian Dollar (AUD).

On Wednesday, the Australian Bureau of Statistics reported that Retail Sales grew at a robust pace of 0.6% from the estimates of 0.2% and the prior release of 0.1%.

Economic Indicator

Retail Sales s.a. (MoM)

The Retail Sales data, released by the Australian Bureau of Statistics on a monthly basis, measures the value of goods sold by retailers in Australia. Changes in Retail Sales are widely followed as an indicator of consumer spending. Percent changes reflect the rate of changes in such sales, with the MoM reading comparing sales values in the reference month with the previous month. Generally, a high reading is seen as bullish for the Australian Dollar (AUD), while a low reading is seen as bearish.

Why it matters to traders?

The primary gauge of Australia’s consumer spending, the Retail Sales, is released by the Australian Bureau of Statistics (ABS) about 35 days after the month ends. It accounts for approximately 80% of total retail turnover in the country and, therefore, has a significant bearing on inflation and GDP. This leading indicator has a direct correlation with inflation and the growth prospects, impacting the Reserve Bank of Australia’s (RBA) interest rates decision and AUD valuation. The stats bureau uses the forward factor method, ensuring that the seasonal factors are not distorted by COVID-19 impacts.

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