AUD/USD falls amid challenging market conditions

Australian dollar/United States dollar (AUD/USD) finished lower last week at 0.6217, a fall of 0.55% for the week. As we enter the closing stages of 2024, AUD/USD is trading nearly 9% below its starting point for 2024 (around 0.6810) and is poised for its weakest monthly close since the challenging days of the Covid-19 pandemic in 2020.

Offshore factors impacting AUD/USD

The downturn in AUD/USD can be largely attributed to offshore factors, including Donald Trump's election victory. This is expected to lead to US fiscal expansion characterised by increased spending and tax cuts. Consequently, this is likely to result in stronger US growth, higher inflation, and subsequently, higher interest rates, all contributing to a stronger USD.Furthermore, Trump's election victory is anticipated to result in tariffs on imports from countries including China, Mexico, Canada, and the European Union (EU). These tariffs will dampen growth expectations outside the US and weigh on commodity prices.

Currency depreciation and global tariffs

Some countries, such as China, have already allowed their currencies to depreciate to mitigate the impact of US tariffs, further weighing on AUD/USD. It is viewed as a more liquid proxy for the Chinese yuan (CNY). The relationship between AUD/USD and USD/CNY is not exact; however, if CNY falls by 2 - 3%, AUD tends to fall by approximately 3 - 5%.

Monetary policy and future outlook

The expected inflationary impact of US tariffs has led to a more cautious outlook regarding Federal Reserve (Fed) rate cuts. This was evident during the last Federal Open Market Committee (FOMC) meeting, where the Fed indicated it expects only two additional 25 basis point (bp) rate cuts in 2025, down from the four it had previously signalled. Expectations of fewer Fed rate cuts in 2025 have provided an additional boost to the US dollar.In Australia, the Reserve Bank of Australia’s (RBA) dovish shift in December and the larger budget deficits projected in the Australian Federal Government's Mid-Year Economic and Fiscal Outlook (MYEFO) report have weighed on the Aussie side of the AUD/USD equation.

What does the outlook for 2025 hold for AUD/USD?

The market's response to Trump's election victory was largely in line with expectations, with the US dollar gaining significantly, especially against the New Zealand dollar (NZD) and AUD. Both of these currencies are vulnerable to risks associated with China tariffs.The fate of AUD/USD in 2025 will largely depend on developments following Trump's inauguration on 20 January. Particular interest will focus on which of Trump's policies are implemented, their timelines, and how they compare to his pre-election promises.In the lead-up to the US election, Trump hinted at raising tariffs on Chinese imports to 60% or higher if re-elected. Currently, approximately 60% of imports from China are subject to tariffs averaging 17%. The market consensus is that Trump's tariffs on China may rise to around 40%. If the actual tariffs are lower than this, it should provide some relief for AUD/USD, however, any increase beyond 40% is likely to weigh heavily on AUD/USD.