- AUD/USD fell to around 0.6790 in early Asian trading on Wednesday.
- Rising geopolitical tensions could weigh on the pair, while expectations of a Fed rate cut could limit any declines.
- Investors will be closely watching Australia's monthly Consumer Price Index (CPI) report on Wednesday.
In early Asian trading on Wednesday, the AUD/USD pair is trading slightly lower around 0.6790. Risk aversion weighs on risk assets such as the Australian dollar (AUD) amid rising geopolitical tensions in the Middle East. Investors will be hoping for fresh stimulus from the Australian monthly Consumer Price Index (CPI) on Wednesday.
Rising geopolitical risks in the Middle East have spurred safe-haven flows that could favor the U.S. dollar in the short term. Thousands of special forces soldiers have been mobilized for a major operation in the northern West Bank that is expected to take several weeks, according to local news agency Al Jazeera.
However, expectations of a Federal Reserve (Fed) interest rate cut are likely to cap the US Dollar (USD) gains and provide some support to AUD/USD. The Fed is expected to cut interest rates in September, by 0.25 percentage points, after Fed Chairman Jerome Powell said on Friday that the time has come for a rate cut.
US consumer confidence continued to improve in August, with the Conference Board's Consumer Sentiment Index rising to 103.3 in August from 101.9 in July (revised from 100.3). However, this data has little impact on the valuation of the US dollar.
Australia's monthly Consumer Price Index (CPI) inflation rate is expected to ease to 3.4% year-on-year in July from 3.8% in June. The weaker-than-expected result could fuel market speculation that the Reserve Bank of Australia (RBA) will cut interest rates later this year.
Frequently asked questions about the Australian dollar
One of the most important factors for the Australian dollar (AUD) is the level of interest rates set by the Reserve Bank of Australia (RBA). As Australia is a resource-rich country, another important factor is the price of its largest export, iron ore. The health of the Chinese economy, its largest trading partner, and Australia's inflation, growth rate, and trade balance are also factors. Market sentiment, i.e. whether investors are holding riskier assets (risk-on) or seeking safe havens (risk-off), is also a factor, and risk-on is positive for the AUD.
The Reserve Bank of Australia (RBA) influences the Australian dollar (AUD) by setting the interest rate levels at which Australian banks can lend to each other, which in turn influences interest rate levels throughout the economy. The RBA's main goal is to maintain a stable inflation rate of 2-3% by adjusting interest rates up and down. Relatively high interest rates compared to other major central banks support the AUD, and vice versa. The RBA can also influence credit terms using quantitative easing and tightening; the former is negative for the AUD and the latter is positive for the AUD.
China is Australia's largest trading partner, so the health of the Chinese economy heavily influences the value of the Australian Dollar (AUD). When the Chinese economy is doing well, it buys more raw materials, goods and services from Australia, which increases the demand for the AUD and makes it more valuable. The opposite is true if the Chinese economy is not growing as expected. Therefore, any surprises, positive or negative, in Chinese growth data often have a direct impact on the Australian Dollar and its pair.
Iron ore is Australia's largest export, worth $118 billion per year according to 2021 data, with China being the main destination. Therefore, the price of iron ore can be a driving force for the Australian dollar. Generally, when the price of iron ore rises, the AUD also rises as the total demand for the currency increases. The opposite is true if the price of iron ore falls. If the price of iron ore rises, Australia's trade balance is also more likely to be in surplus, which is also beneficial for the AUD.
The trade balance, the difference between the income earned from exports and the amount paid for imports, is another factor that affects the value of the Australian dollar. If Australia produces exports that are in high demand, the value of the Australian currency will only rise from the excess demand that arises from foreign buyers wanting to buy the exports and the amount they spend on buying the imports. Thus, if the trade balance is positive, the value of the Australian dollar will rise and if the trade balance is negative, it has the opposite effect.
