AUD/USD Outlook: Inflation shifts RBA bets, but tech earnings drive the Aussie

• Headline CPI jumps 1.1% in March, annual pace accelerates to 4.6%
• Quarterly trimmed mean at 0.8% undershot RBA forecasts
• Three RBA hikes still favoured this year despite softer May pricing
• Risk appetite may matter more than rates for AUD/USD

Summary

Australian inflation accelerated sharply in March as the early impact of the Iran war flowed through via higher energy prices, but the overall result was not as severe as feared and underlying measures did not materially worsen. That helped trim expectations for the scale of further RBA tightening, although markets still see a high chance of a hike next week with another two moves largely priced by year-end.

For AUD/USD, the inflation report triggered only a brief dip, suggesting rate expectations are not the main driver right now. Instead, the Aussie appears more tied to broader risk sentiment, leaving the near-term focus on US tech earnings, the FOMC decision and whether the pair can hold above former resistance near .7158.

Hot headline, calmer underneath… for now

Headline inflation jumped 1.1% in March, leaving the increase from a year earlier at 4.6%, two tenths beneath the median economist forecast of 4.8%. The monthly gain was driven primarily by a 32.8% surge in automotive fuel prices, the largest increase since the series began in 2017, reflecting the earlier spike in global energy prices tied to the Iran conflict. Housing also remained a major contributor, with electricity prices elevated following the expiry of government rebates.

Source: ABS

Of more importance to markets and the RBA, underlying price pressures remained relatively contained, albeit at uncomfortably high levels. Trimmed mean inflation, which measures the average price increase across the ABS basket once the top and bottom 15% of weighted price moves are removed, rose 0.3% over the month, up from 0.2% in February but in line with market expectations. From a year earlier, it remained at 3.3%.

With the monthly inflation series only relatively new in Australia, the RBA continues to place heavy weight on quarterly trimmed mean outcomes, the measure it relied on before the monthly series was introduced late last year. While still running at levels inconsistent with the Bank achieving its 2.5% inflation target, the good news was the 0.8% quarterly outcome was a tenth below both the RBA and median economist forecast, slowing slightly from the 0.9% pace seen in the final quarter of last year. From a year earlier, this key inflation measure ticked up to 3.5%, in line with forecasts and a tenth above the prior quarter.

There was clear evidence of an early Iran war pass through in the trade-exposed parts of the basket. Annual tradables inflation, covering items more exposed to global pricing forces such as fuel, food, clothing and footwear, jumped to 4.5% in March from 1.3% in February.

By contrast, annual non-tradables inflation, covering areas driven more by domestic factors such as housing and education, eased to 4.6% from 5.0%. Electricity, new dwellings and rents remained the key contributors, suggesting home-grown price pressures are still elevated even if the pace is cooling gradually.

Source: ABS

The same split was visible in goods and services. Annual goods inflation accelerated sharply to 5.5% from 3.5%, while annual services inflation slowed to 3.6% from 3.9%, with rents and medical and hospital services the main contributors. Services inflation looked to have topped out prior to the Iran war, but the key question now is how quickly higher energy prices begin to spill into broader domestic pricing pressures.

That is the main caveat with this report. It captures only the early impact of the Iran war on prices, which naturally hits tradable goods first. What matters now is how long higher energy prices remain in place. The longer they persist without causing an immediate hit to demand and activity, the greater the risk the inflation pulse from tradable goods spreads elsewhere through higher inflation expectations, stronger wage demands and broader second round effects.

Softer core tempers RBA May pricing

Source: TradingView

On the back of the data, implied probability of an RBA rate hike in May fell marginally, according to interbank futures markets, easing from above 90% to 83%. Traders know Australia had an inflation problem before the war started, the question now is how much worse it will become in the June and September quarters. As such, beyond the high probability of a hike next week, another two are nearly fully priced by the end of the year, an outcome that would leave the cash rate at 4.85% if realised.

Mirroring the pullback in rate hike probabilities for May, AUD/USD dipped following the release of the inflation report, although it is notable the weakness was not acute by any means. That is probably because the Aussie has been more sensitive to risk appetite recently rather than rate differentials.

Risk appetite over rates

Source: TradingView

As seen in the correlation matrix insert on the chart above, multiple drivers appear to be competing for influence over Aussie dollar direction right now, with AUD/USD demonstrating a modest correlation with yield differentials and risk appetite, along with a reasonable negative relationship with energy prices and USD/CNH over the past week.

However, while the correlation with the yuan has softened a touch, the link with risk appetite, as proxied by S&P 500 futures, has strengthened, suggesting it is currently the primary driver of the pair’s performance. That places just as much emphasis on earnings updates from Alphabet, Amazon, Microsoft and Meta over the next 24 hours as on the FOMC monetary policy decision.

AUD/USD nears support zone

Source: TradingView

Despite the latest pullback, AUD/USD continues to grind higher on the H4 chart, remaining just beneath the multi-year high of .7222 set earlier this month. It now sits just above the February 2023 swing high of .7158, a level it has spent ample time around over the past fortnight.

With the oscillators pointing to waning upside strength while remaining in neutral territory, the preference remains to keep an open mind on both long and short setups, placing greater emphasis on the price action to guide direction.

On the downside, the intersection of the February 2023 high with minor uptrend support established earlier this month makes for a decent level to build setups around should the price return there. A test and bounce would allow for longs to be set with a tight stop below, targeting .7200 initially and the March high of .7222 after that.

But if the price were to break beneath the intersection and hold there, shorts could be set with a tight stop above, targeting .7120 or .7100, with .7150 a reference point located in between.