Australian dollar outlook: CPI moves into view

Australian dollar forecast: Neutral

The Australian dollar ran to a new peak last week as the US dollar got crunched with data revealing a rocky road ahead for the world’s largest economy. Then the market realised the broader implications for global growth and AUD/USD swiftly fell back to earth.

US retail sales and PPI provided that catalyst for volatility with both sets of numbers missing estimates. Several Fed speakers also reiterated their hawkish stance in the aftermath, and this highlighted that US rates might go higher than what the market is currently pricing in.

Futures and swaps markets see a peak in rates somewhere near 4.90% later this year before decreasing. Most Fed speakers have said that they see rates going to 5% or above there and staying that high for a long period.

From a broad perspective, if the Fed does what they say they are going to do, the upshot for markets could be two-fold. The higher returns on offer might be supportive of the US dollar. Then the impact on the US economy by applying the brakes to growth may undermine risk assets further.

For now, markets don’t believe the Fed will do that. The data last week put the cat among the pigeons to a degree, but this might have further to play out.

Domestically, it is a big week ahead with the fourth quarter Australian CPI due out on Wednesday. A Bloomberg survey of economists anticipates a year-on-year headline rate of 7.6%, up from the third quarter reading of 7.3%.

The RBA has said that they expect inflation to peak at 8% later this year before easing into next year, remaining well above their mandated 2-3% target band.

A print above 7.6% would flag a problem for the central and could alter expectations for their February monetary policy meeting. The futures market is currently pricing around a 15 bp increase in the cash rate target, reflecting uncertainty between a 25 bp lift or no change.

In the background, the China re-opening story continues to unfold and the Chinese New Year travel and celebrations might see a significant increase in Covid-19 cases. Nonetheless, commodity prices remain elevated, particularly iron ore, copper, aluminium and gold which are all top exports for Australia.

Chart: AUD/USD, iron ore, copper, gold, DXY Index

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