FX.co ★ AUD/USD. Echoes of the inflation report, three scenarios for the Fed and the aussie's outlook

On Friday, the AUD/USD came close to the 0.7000 mark. This is the most important psychologically significant resistance level, crossing it, as a rule, is accompanied by a long, sometimes months-long siege. So it is not surprising that the bulls did not conquer the strategically important landmark without a fight. The pair approached 0.6995, but then reversed and headed towards the base of the 69th figure.

Swing for the greenback

Notably, the aussie got weaker amid an almost empty economic calendar. The upward momentum faded solely due to the greenback's strength. The U.S. dollar index was able to stall around the 102nd figure, after plunging down, amid slowing inflationary growth in America. Plus, the notorious Friday factor, which also had a significant impact on the values of the major currencies. The AUD/USD pair was not an exception here: after it failed to reach 0.7000, traders rushed to take profit before the weekend. And so the upward momentum stopped, which we observed during Friday's European trading session.

Can we talk about a trend reversal under such conditions? Obviously not. Moreover, there are no fundamental prerequisites for this. The information background is now conducive to the greenback getting weaker. In this regard, traders were hesitant about this because of the weekend. But if we disregard situational decisions, we can come to a definite conclusion: it will be very difficult for the US dollar to change the situation in its favor after the release of the US inflation data for December. Let me remind you that both the general consumer price index and the core index showed a downtrend.

The implications of the inflation report

Supporters of the strong dollar contradict their opponents - they say that all components of the inflation report came out as forecasted, and the decline in overall inflation is primarily due to a 9% decline in gasoline prices (which may also rise rapidly in price in the coming months). In the same context, they point to the resurgence in the oil market - the price of crude oil has reached its highest level in 10 days. In other words, the dollar bulls are insisting that the current situation is unsteady, with major inflation indicators showing a downtrend.

However, most traders and investors are still confident in the opposite. Judging by the rhetoric of most experts, U.S. inflation has peaked - not last month, but in late summer, after which all major inflation indicators have "bowed their heads," reflecting a slowdown in inflation.

The latest inflation served as the "control shot". The report confirmed the trends, allowing traders and currency strategists to model further developments. To be more precise, in this case we are talking about modeling possible Federal Reserve decisions, in the light of slowing inflation and quite good data on the growth of the US labor market.

Three scenarios for the Fed

Among all the possible changes (concerning the decisions made at the December meeting) in Fed policy, experts identify several possible ones. Or rather, three.

First, the Fed may again lower the rate of interest rate increases - now from 50 to 25 points;

Second, the Fed may "prematurely" complete the current tightening cycle by revising down the final rate (now the upper limit is at 5.1%);

Thirdly, the central bank may start cutting the interest rate in the second half of 2023 or at the end of the current year.

All of the options have been discussed before, but now that the decline in US inflation has taken a steady form, they are looked at, so to speak, "from a practical point of view". But here we need to distinguish valuable things from worthless ones.

For example, the most realistic scenario is a slowdown in monetary tightening. The probability of a 25-point rate hike at the end of the February meeting is now estimated at 93% (although just a week ago the probability was 55%.).

As for an early end to the current cycle of rate hikes, this option is not ruled out either, but even the most ardent supporters of dovish decisions put a question mark here. In my opinion, this is the main intrigue of the February meeting. At the end of the last December meeting, Fed Chairman Jerome Powell emphasized that the pace and scope of further tightening of the monetary policy would depend on incoming data. Apparently, so far the conditions are in place for slowing the rate hike. But is the central bank ripe for a downward revision of the final point of the current cycle? This is an open question.

Also, the market is now discussing another possible reversal, which is in the form of a rate cut within the current year. In my opinion, this is the most unlikely scenario. Here we can recall the minutes of the December FOMC meeting and Powell's repeated statements - that the central bank will keep rates high even in the face of a sustained slowdown in inflation. I believe the central bank will refute these rumors in a separate line at the February meeting.

However, the relevant discussion in the expert environment, the subject of which is exclusively dovish scenarios (differing among themselves only in the degree of "softness") - is already weighing on the greenback.

Even against the Australian dollar, the fundamental background for which is positive. China abandoning its "zero-Covid" policy, the improvement in Australia-China relations, the continuing rise in inflation - all these factors are playing into the aussie's hands. It's also worth recalling here that the Reserve Bank of Australia lowered the rate hike back last fall. At the same time, the Australian central bank has assured the markets that it will continue to raise rates, refuting rumors of a possible pause. The latest inflation report, which reflected the renewed growth of inflation in Q4 2022, became a kind of guarantee that the RBA will maintain a hawkish course in the near future.

Conclusions

In my opinion, it is too early to write off the aussie. On the contrary, the current price decline is a positive moment for the bulls because it is simply dangerous to open long positions near the resistance level of 0.7000. At the same time it would be better to consider the bearish pullback as an opportunity to open longs: if the pressure on the greenback persists (which is highly probable), the bulls will try to cross the key resistance level of 0.7000 again.