AUD/USD steady after US inflation drops to 2.5%

The Australian dollar dipped lower earlier but has recovered. In the North American session, AUD/USD is trading at 0.6655, up 0.04%.

Smaller Fed cut more likely after drop in CPI

The eagerly-anticipated US inflation report came in as expected and didn’t have much impact on the movement of the US dollar. Headline CPI eased to 2.5% y/y in August, down from 2.9% in July and matching expectations. This was the fifth straight decline in headline inflation, an encouraging sign for the Federal Reserve ahead of a crucial meeting on Sept. 18.

Monthly, CPI was unchanged at 0.2%, in line with the market estimate. Core CPI, which remains a bit high, was unchanged at 3.2% y/y, matching the market estimate. Monthly, the core rate ticked up to 0.3%, up from the July gain of 0.2% and the market estimate of 0.2%.

What can we expected from the Federal Reserve next week? The easy answer is that a rate cut is almost guaranteed. The tougher question is will the Fed start its new rate-lowering cycle with a modest 25-basis point cut or deliver an oversize cut of 50 bps?

Market rate cut odds have been swinging wildly, as expectations for a 50-bps cut surged following the July and August nonfarm payroll reports. The US labor market is finally showing wide cracks due to elevated interest rate levels, and investors are jittery that a weaker-than expected labor market could lead to a recession.

The odds of a 50-bps cut surged to 59% after the soft nonfarm payroll report on Friday, but were down to 27% just prior to today’s inflation report and have fallen to 15% following the release, according to the CME’s FedWatch. This puts the likelihood of a 25-bps cut at 85%. The rate cut odds are likely to continue to shift as we move closer to the Fed meeting.

AUD/USD Technical

• AUD/USD is testing resistance at 0.6655. Above, there is resistance at 0.6673
• 0.6637 and 0.6621 are the next support levels

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