AUD/USD strengthens on hopes of narrowing Fed-RBA policy divergence

• AUD/USD holds gains near a five-month high of around 0.6730 on firm hopes that the Fed-RBA policy divergence will be narrowed soon.
• Weak US labor demand in the private sector and contraction in Services PMI have strengthened early Fed rate-cut hopes.
• Reserved disinflation and robust Retail Sales growth have prompted RBA rate hike bets.

The AUD/USD pair trades close to a five-month high near 0.6730 in Thursday’s American session. The Aussie asset strengthens amid firm speculation that the policy divergence between the Federal Reserve (Fed) and the Reserve Bank of Australia (RBA) would narrow.

Investors expect the Fed to start reducing interest rates from the September meeting. According to the CME FedWatch tool, 30-day Federal Funds Futures pricing data shows that the probability of rate cuts in September has improved to 72.6% from 66% recorded a week ago. The data also shows that the Fed will cut interest rates twice this year, which has improved investors' risk appetite. S&P 500 futures have posted nominal gains in European trading hours.

Early Fed rate cut expectations have been prompted by deepening concerns over the United States' (US) economic strength. The economy appears to have lost momentum in the second quarter, as the ISM Services PMI contracted in June. The Services PMI, a measure of activities in the service sector, which accounts for two-thirds of the economy, declined below the 50.0 threshold to 48.8 from expectations of 52.5 and the prior release of 53.8.

Also, labor demand in the private sector unexpectedly declined in June, which raised concerns over US labor market strength. Weak US data has weighed heavily on the US Dollar (USD). The US Dollar Index (DXY) has declined to near 105.20.

On the contrary, financial markets expect that the Reserve Bank of Australia (RBA) could tighten its policy further. Reversed disinflation and stronger-than-expected monthly Retail Sales have boosted the possibility of more rate hikes by the RBA. This has also strengthened the Australian Dollar (AUD).

On Wednesday, the Australian Bureau of Statistics reported that Retail Sales grew at a robust pace of 0.6% from the estimates of 0.2% and the prior release of 0.1%.