Can AUD/USD recover from its drop below 0.6100 amid trade tensions?

AUD/USD breaks below 0.6100

AUD/USD finished lower last week at 0.6210 (-1.64%) amid expectations that the Reserve Bank of Australia (RBA) will begin cutting interest rates in February, following the White House's reaffirmation of plans for 25% tariffs on Mexico and Canada.

Trump's tariff announcement shocks markets

President Trump's announcement was more aggressive than anticipated. The 25% tariffs on Canada and Mexico will take effect this Tuesday, quashing hopes for a one-month delay. It also included the possibility of further tariffs if these countries retaliate, with Trump suggesting that tariffs on Europe are imminent.

China's measured response and impact on AUD/USD

This weekend’s announcement also introduced a 10% tariff on China, contrary to market expectations of a later introduction, likely after smoother negotiations with Canada and Mexico. China's response has been relatively restrained. While it has promised retaliation, it has not enacted new tariffs.

Instead, China plans to file a complaint against the United States (US) at the World Trade Organization (WTO), arguing that the tariffs violate international trade regulations. It's possible that China's muted response is because the 10% tariff rate is lower than expected and the tariff rationale - focused on fentanyl - applies to multiple countries, not just China.

While it’s positive for AUD/USD that China has avoided escalating the situation, the combination of a looming trade war, broad-based risk aversion, and the imminent start of an RBA rate-cutting cycle will likely keep pressure on its value.

Impact of lower AUD/USD on RBA rate cuts

Some concerns may arise that a lower AUD/USD could lead to a rebound in inflation and possibly delay the RBA’s rate-cutting cycle, but this is unlikely. It's important to remember that the RBA focuses on the core inflation measure, the trimmed mean, which excludes volatile items like fuel prices. Thus, rising petrol costs do not necessarily decrease the likelihood of a rate cut.

Sustained inflation in Australia (AU) in recent years has mainly stemmed from the services sector, less affected by changes in the AUD/USD exchange rate. Additionally, if the trade war of 2025 escalates and economic growth slows both domestically and internationally - given that growth in AU has already been sluggish - it could prompt the RBA to expedite its rate-cutting measures.

During significant economic shocks, the Australian dollar often acts as a buffer for the economy, a role it has admirably performed in the past.

AUD/USD technical analysis

From its late September 2024 high of 0.6942 to today’s low of 0.6087, AUD/USD has fallen by approximately 12.5% over four months. After a tentative bounce from the mid-January low of 0.6131 to the late January high of 0.6330, the downtrend has resumed and gained momentum with today’s gap lower.

Unless AUD/USD can fill the gap to 0.6200 and then rebound above a band of resistance at 0.6350 - 0.6370, the risks are for a test of the psychologically significant 0.6000 level before a move lower towards 0.5700.

AUD/USD daily chart

• _{Source: TradingView. The figures stated are as of 3 February 2025. Past performance is not a reliable indicator of future performance. This report does not contain and is not to be taken as containing any financial product advice or financial product recommendation.}