AUD/USD retraces from three-week high of 0.6400, Fed policy in focus
- AUD/USD falls sharply from the three-week high of 0.6390 as the Australian Dollar faces profit booking after a sharp rally on Monday.
- China’s fresh monetary stimulus plan has increased the AUD’s appeal.
- Investors await the Fed’s monetary policy decision, dot plot, and Summary of economic projections on Wednesday.
The AUD/USD pair corrects to near 0.6355 during North American trading hours on Tuesday after posting a fresh three-week high at 0.6390 on Monday. The Aussie pair slumps as the US Dollar (USD) ticks higher, with the US Dollar Index (DXY) attracting bids after revisiting the five-month low of 103.20.
However, the Greenback is expected to trade cautiously as the Federal Reserve (Fed) is scheduled to announce the second interest rate decision of the year on Wednesday. The Fed is almost certain to keep borrowing rates steady in the range of 4.25%-4.50% for the second time in a row.
Market participants will pay close attention to the Fed’s dot plot and Summary of Economic Projections (SEP) to get cues over interest rates, inflation, and the economic outlook. In the December policy meeting, Fed officials collectively guided two interest rate cuts for 2024.
Meanwhile, the Australian Dollar (AUD) performed strongly in the last two trading sessions on renewed optimism over China’s economic outlook. Over the weekend, China announced a comprehensive “special action plan”, which will primarily focus on increasing households’ income to boost domestic consumption. This scenario is favorable for the Australian Dollar, given that the Australian economy relies heavily on exports to China.
On the domestic front, the Reserve Bank of Australia (RBA) is expected to maintain a ‘cautious’ stance on the interest rate policy as US President Donald Trump's tariff war could accelerate inflationary pressures in the Australian economy.
RBA Assistant Governor Sarah Hunter said on Monday that she is focusing on the US policy settings and how they will impact inflation.
US Dollar FAQs
The US Dollar (USD) is the official currency of the United States of America, and the ‘de facto’ currency of a significant number of other countries where it is found in circulation alongside local notes. It is the most heavily traded currency in the world, accounting for over 88% of all global foreign exchange turnover, or an average of $6.6 trillion in transactions per day, according to data from 2022. Following the second world war, the USD took over from the British Pound as the world’s reserve currency. For most of its history, the US Dollar was backed by Gold, until the Bretton Woods Agreement in 1971 when the Gold Standard went away.
The most important single factor impacting on the value of the US Dollar is monetary policy, which is shaped by the Federal Reserve (Fed). The Fed has two mandates: to achieve price stability (control inflation) and foster full employment. Its primary tool to achieve these two goals is by adjusting interest rates. When prices are rising too quickly and inflation is above the Fed’s 2% target, the Fed will raise rates, which helps the USD value. When inflation falls below 2% or the Unemployment Rate is too high, the Fed may lower interest rates, which weighs on the Greenback.
In extreme situations, the Federal Reserve can also print more Dollars and enact quantitative easing (QE). QE is the process by which the Fed substantially increases the flow of credit in a stuck financial system. It is a non-standard policy measure used when credit has dried up because banks will not lend to each other (out of the fear of counterparty default). It is a last resort when simply lowering interest rates is unlikely to achieve the necessary result. It was the Fed’s weapon of choice to combat the credit crunch that occurred during the Great Financial Crisis in 2008. It involves the Fed printing more Dollars and using them to buy US government bonds predominantly from financial institutions. QE usually leads to a weaker US Dollar.
Quantitative tightening (QT) is the reverse process whereby the Federal Reserve stops buying bonds from financial institutions and does not reinvest the principal from the bonds it holds maturing in new purchases. It is usually positive for the US Dollar.