AUD Reaction to Strong Inflation Data Muted Ahead of Fed

The Australian and New Zealand Dollars are trading mixed on Tuesday as investors prepare for tomorrow’s major Federal Reserve announcements.  Both currencies are on the defensive as global stock markets extended their slide and geopolitical tensions further clouded the mood. However, the Aussie is getting a favorable boost due to a surprise jump in domestic inflation.

At 08:57 GMT, the AUD/USD is trading .7144, down 0.0001 or -0.03% and the NZD/USD is at .6673, down 0.0026 or -0.39%. On Monday, the Invesco CurrencyShares Australian Dollar Trust ETF (FXA) settled at $70.85, down $0.37 or -0.52%.

The Aussie and Kiwi are trying to recover from Tuesday’s steep sell-off that was fueled by a plunge in U.S. equity markets as investors reacted to the threat of a conflict between Ukraine and Russia, and the possibility of more aggressive moves by the Federal Reserve on Wednesday.

Both currencies are leveraged to global growth and commodity prices and tend to get sold when markets turn bearish, Reuters wrote.

Australian Core Inflation Beats Forecasts

Concerns over geopolitical events and the Fed were dampened after Australian domestic data showed core inflation jumped to an annual 2.6% in the December quarter, blowing away forecasts of 2.3% and above the middle of the Reserve Bank of Australia’s (RBA) 2-3% target band.

Aussie Speculators Increase Bets on Earlier-Than-Expected RBA Rate Hike

Tuesday’s surprise inflation numbers encouraged speculators to increase market wagers on an early rise in interest rates, with futures now almost fully-priced for a move to 0.25% in May.

The market now has four more hikes priced in for this year, taking rates to 1.25% by December, more even that for the U.S. Federal Reserve where inflation is twice the Australian level.

Investors also dumped shorter-dated bonds with three-year futures sliding 9 ticks to 98.500, implying a yield of 1.5%.

Investors Shift into Fedwatch Mode

After posting wide trading ranges on Tuesday, the Aussie and Kiwi are moving inside yesterday’s ranges, suggesting investor indecision and impending volatility.

Market participants are awaiting the Federal Open Market Committee’s meeting this week for clues as to how much the central bank will raise interest rates this year and when it will start.

The Fed’s January two-day policy meeting is due to start Tuesday and conclude Wednesday. Forecasts are calling for the Fed to announce four rate hikes this year, but Goldman Sachs thinks the bank may see risk for more rate increases due to the surge in inflation.

Short-Term Outlook

The RBA holds a policy meeting on February 1 and is still thought likely to hold rates at 0.1%. Although it will be harder, some policy makers will still argue that a rise in rates is unlikely until 2023.

Meanwhile, the price action in the AUD/USD suggests traders are having a hard time believing a rate hike would reverse the Aussie’s recent decline.