AUD Caught in a Squeeze: Inflation Spike Fails to Spark Recovery as USD Strengthens

Australian Dollar tumbles for the sixth consecutive day despite inflation expectations surging to 4.7%, casting doubt on the rally narrative. While inflation pressures mount, markets are pricing in a cautious RBA stance rather than aggressive rate hikes. The USD stands firm as Fed rate cut bets evaporate, leaving AUD traders trapped between hawkish local signals and a stronger greenback.

The Australian Dollar faces an unusual paradox this week. Typically, a jump in consumer inflation expectations—rising from 4.5% in November to 4.7% in December—should ignite demand for the AUD as investors brace for aggressive central bank tightening. Instead, the AUD/USD pair has rolled over to trade below 0.6600, extending losses for a sixth straight session. This disconnect reveals much about current market dynamics and the forces reshaping currency valuations across the developed world.

The Inflation Signal That Didn’t Trigger a Rally

Australia’s inflation expectations reading lands amid a complex backdrop. Major domestic banks, including Commonwealth Bank of Australia and National Australia Bank, are now flagging the possibility of an RBA rate hike as soon as February—a more hawkish timeline than previously forecast. The central bank’s resolute hold on rates at its final 2025 meeting underscored a commitment to addressing stubborn inflation pressures in a capacity-constrained economy.

Yet swaps markets are pricing this scenario with considerable caution: just 28% odds assigned to a February hike, though March probability climbs to 41% and August is nearly fully priced. This measured positioning suggests traders view the RBA’s next moves as telegraphed rather than imminent surprises. Meanwhile, the same inflation backdrop that should boost AUD is being drowned out by a far more powerful force: US Dollar strength anchored to fading Fed easing expectations.

The USD Fortress Emerges as Fed Pivots to Patience

The US Dollar Index (DXY), tracking greenback performance against six major peers, clings near 98.40 as the probability of additional Federal Reserve rate cuts evaporates. The December jobs report served as a turning point: payroll growth of 64K modestly beat forecasts, but October revisions sliced sharply lower, and unemployment ticked up to 4.6%—the highest since 2021. Retail sales flatlined month-over-month, painting a picture of consumer fatigue alongside a gradually cooling labor market.

Atlanta Fed President Raphael Bostic signaled the hesitation gripping policymakers. In a Tuesday blog post, he characterized the jobs report as a mixed picture offering no fresh policy guidance. More telling: he cited “multiple surveys” pointing to elevated input costs, with firms determined to preserve margins through price increases. Bostic cautioned against premature claims of victory on inflation, warning that “price pressures are not just coming from tariffs.”

Fed officials remain divided on 2026 easing. The median projection pencils in just one rate cut next year, while some policymakers see no reductions at all—a stark contrast to trader expectations of two cuts. The CME FedWatch tool now prices a 74.4% probability of a rate hold at the January meeting, up from 70% a week prior. This shift from cutting to holding represents a seismic recalibration that naturally props up the USD.

China’s Stumbling Momentum Adds to the Headwinds

Global growth concerns have also entered the fray. China’s November retail sales rose just 1.3% year-over-year, undershooting the 2.9% consensus and the prior month’s 2.9% reading. Industrial production climbed to 4.8% YoY versus a 5.0% forecast, while fixed asset investment landed at -2.6% year-to-date YoY, missing the -2.3% expected figure. These soft prints ripple through commodity and currency markets, dampening appetite for currencies of commodity-linked economies like Australia.

Domestic Data Adds Complexity to the AUD Picture

Australia’s economic calendar brought mixed signals. The preliminary S&P Global Manufacturing PMI edged up to 52.2 from 51.6, a modest improvement. However, Services PMI slipped to 51.0 from 52.8, while the Composite PMI fell to 51.1 from 52.6—suggesting momentum may be fading. On employment, the November Unemployment Rate held steady at 4.3%, undercutting the 4.4% consensus. Yet employment change swung to -21.3K from October’s revised 41.1K, a jarring deterioration that surprised to the downside relative to the 20K forecast.

This employment shock, coupled with softer services activity, tempers enthusiasm for an imminent RBA pivot toward tightening despite inflation creeping higher. The central bank may find itself in a tightening cycle, but not the aggressive, shock-and-awe kind that would supercharge AUD.

Technical Breakdown: AUD/USD Breaks Key Support

From a technical perspective, AUD/USD has fractured below the ascending channel that framed the recent bullish bias. Trading now beneath 0.6600 and the nine-day Exponential Moving Average (EMA) at 0.6619, the pair exhibits weakening short-term momentum. The psychological 0.6500 level looms as the next downside target, followed by the six-month low of 0.6414 established on August 21.

A rebound would need to reclaim the nine-day EMA and the ascending channel. Success there could propel the pair toward the three-month high of 0.6685, followed by 0.6707 (the highest since October 2024). A decisive break above that zone could test the upper channel boundary near 0.6760.

What This Means for Cross-Rate Traders

The AUD weakness has ramifications for related pairs. For traders monitoring EUR/AUD dynamics or converting between 103 euro to AUD equivalent valuations, the Australian Dollar’s extended slide raises the cost of euro holdings against the Aussie and reshapes conversion calculus across the currency complex. As the AUD deteriorates, so too does the relative attractiveness of AUD-denominated assets for international investors.

The Bottom Line

The Australian Dollar finds itself whipsawed between conflicting forces: domestic inflation pressures supporting eventual RBA hikes versus a resurgent US Dollar anchored to Fed patience and global growth headwinds. Until the RBA signals a more aggressive tightening path—or global risk appetite rebounds—AUD bears appear poised to extend their advantage. The technical breakdown below 0.6600 could open the door to further losses, though eventual oversold conditions may eventually invite mean-reversion bounces toward the 0.6680-0.6700 zone. For now, the USD fortress trumps inflation expectations, leaving AUD traders in a holding pattern.