Australian Dollar drops lower after Fed's favourite inflation guage shows upswing

The Australian Dollar plunges through support following the release of US Q2 GDP.
Downside pressure maintains on the Aussie after the release of US PCE inflation data for June.
The Fed Chairman said he could not confirm if there would be further rate hikes, noted a fall in Core CPI and strength in the labor market.

The Australian Dollar (AUD) plummets against the US Dollar (USD) on Friday, breaking through all major daily Simple Moving Averages (SMA) as it extends loses after the release on Thursday of better-than-expected US GDP data for the second quarter. An unexpected rise in the Federal Reserve's (Fed) preferred inflation gauge, Personal Consumption Expenditure (PCE), on a month-on-month basis, on Friday, keeps up the downside pressure on the pair.

Headline PCE rose by 0.2% on a MoM basis in June – well above the -0.1% forecast and the 0.1% previous, according to data from the US Bureau of Economic Analysis. On a YoY basis PCE rose by only 3.0%, which was below the 3.1% expected and 3.8% reported in May.

Core PCE gained 0.2% MoM, inline with expectations and below the previous month of May's 0.3%. On a YoY basis it showed a lower 4.1% increase in prices compared to the 4.2% expected and 4.6% previous.

AUD/USD trades in the upper 0.66s during the US session on Friday.

Australian Dollar news and market movers

The Australian Dollar weakens versus the US Dollar after US GDP data shows stronger-than-expected growth.
A rise in monthly inflation according to the Fed's preferred gauge, the PCE index, adds further downside pressure on the Aussie as it suggests bouyant inflation and the potential for higher interest rates in the US, which would be favorable for the Buck.
US Gross Domestic Product (GDP) expanded at an annualized rate of 2.4% in the second quarter, first estimates showed on Thursday. This reading followed the 2% growth recorded in the first quarter and surpassed the market expectation of 1.8% by a wide margin.
Durable Goods Orders jumped 4.7% on a monthly basis to reach $302.5bn, according to the US Department of Commerce, in seasonally adjusted terms.
Initial Jobless Claims decreased by 7,000 to 221,000 in the week ending July 22 – below the 235,000 gain forecast. Continuing Claims fell to 1.69 million versus the 175M forecast.
The Australian Dollar rebounded following the Fed meeting. The FOMC raised rates by 0.25% – as expected. However, Chairman Powell showed more-than-expected optimism in his post-meeting press conference.
Powell noted how core inflation was coming down, how the labor market was showing remarkable resilience, and how the Fed would be taking a meeting-by-meeting approach to policy from now on. The market interpreted this as a dovish turn.
The release of Australian Consumer Price Index (CPI) data for Q2 dragged the Aussie lower early Wednesday after it showed a steeper-than-expected slowdown in inflation.
Australian CPI inflation came out at 6.0% in Q2 YoY when 6.2% had been forecast versus the 7.0% in Q1.
The Reserve Bank of Australia’s (RBA) preferred gauge, RBA Trimmed Mean CPI, measured quarterly, increased by 5.8% YoY in Q2 versus the 6.0% rise estimated and the 6.6% of Q1.
There is a risk that the RBA will have to cut rates in 2024 because the Australian housing market is dominated by variable-rate mortgages so it is more sensitive to interest rates, and homeowners have recently been adversely affected by higher mortgage repayments, according to Bloomberg Intelligence, as quoted by Financial Review.
The RBA’s Cash Rate is 4.1%, which is below the Fed’s 5.50%, overall favoring capital flows to the Greenback versus the Aussie.
China’s pledge to increase support for the economy on Monday has helped the Australian Dollar since it is Australia’s largest trading partner.

Australian Dollar technical analysis

AUD/USD is in a sideways trend on both the long and medium-term charts. The February high at 0.7158 is a key hurdle, which if vaulted, will alter the outlook to one that is more bullish longer term.

Likewise, the 0.6458 low established in June is a key level for bears, which if breached decisively, would give the chart a more bearish overtone from a longer-term perspective.

Australian Dollar vs US Dollar: Weekly Chart

The confluence of support made up of all the major daily SMAs – the 50, 100 and 200 – that formed a barrier in the upper 0.66s and lower 0.67s has given way overnight. If the exchange rate manages to close well below the SMAs on a daily basis then a decisive break will suggest more downside it on the cards.

Australian Dollar vs US Dollar: Daily Chart

From a bullish perspective, a recovery and decisive break above the June 16 high at 0.6900 would now be required to save the day and provide stronger confirmation of a more bullish outlook.

A decisive break consists of a long daily candlestick, which pierces cleanly above or below the critical level in question and then closes near to the high or low of the day. It can also mean three up or down days in a row that break cleanly above or below the level, with the final day closing near its high or low and a decent distance away from the level.

Inflation FAQs

What is inflation?

Inflation measures the rise in the price of a representative basket of goods and services. Headline inflation is usually expressed as a percentage change on a month-on-month (MoM) and year-on-year (YoY) basis. Core inflation excludes more volatile elements such as food and fuel which can fluctuate because of geopolitical and seasonal factors. Core inflation is the figure economists focus on and is the level targeted by central banks, which are mandated to keep inflation at a manageable level, usually around 2%.

What is the Consumer Price Index (CPI)?

The Consumer Price Index (CPI) measures the change in prices of a basket of goods and services over a period of time. It is usually expressed as a percentage change on a month-on-month (MoM) and year-on-year (YoY) basis. Core CPI is the figure targeted by central banks as it excludes volatile food and fuel inputs. When Core CPI rises above 2% it usually results in higher interest rates and vice versa when it falls below 2%. Since higher interest rates are positive for a currency, higher inflation usually results in a stronger currency. The opposite is true when inflation falls.

What is the impact of inflation on foreign exchange?

Although it may seem counter-intuitive, high inflation in a country pushes up the value of its currency and vice versa for lower inflation. This is because the central bank will normally raise interest rates to combat the higher inflation, which attract more global capital inflows from investors looking for a lucrative place to park their money.

How does inflation influence the price of Gold?

Formerly, Gold was the asset investors turned to in times of high inflation because it preserved its value, and whilst investors will often still buy Gold for its safe-haven properties in times of extreme market turmoil, this is not the case most of the time. This is because when inflation is high, central banks will put up interest rates to combat it.
Higher interest rates are negative for Gold because they increase the opportunity-cost of holding Gold vis-a-vis an interest-bearing asset or placing the money in a cash deposit account. On the flipside, lower inflation tends to be positive for Gold as it brings interest rates down, making the bright metal a more viable investment alternative.

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