The Australian Dollar/US Dollar (AUD/USD) pair is trading slightly higher near 0.6710 during the European trading session on Tuesday. The Australian pair rises as the Australian dollar (AUD) strengthens on expectations that the Reserve Bank of Australia (RBA) will tighten monetary policy in 2026.
The Reserve Bank of Australia’s hawkish forecasts support lower inflation expectations. In the policy announcement earlier this month, officials indicated they were willing to tighten policy if inflation failed to decline as expected.
Ahead of the Reserve Bank of Australia’s next monetary policy announcement in February, investors will focus on November CPI data, which will be released in January.
Meanwhile, the US Dollar (USD) is trading flat ahead of the release of the Federal Open Market Committee (FOMC) minutes for its December meeting late in the New York session. At the policy meeting, the Fed cut interest rates by 25 basis points to 3.50%-3.75% and indicated that there would be only one more point in 2026. In 2025, the Fed cut borrowing rates three times.
Next year, the main driver for the US dollar will be the announcement of the replacement of Federal Reserve Chairman Jerome Powell. US President Donald Trump said on Monday that he will announce a new head of the Federal Reserve sometime in January.
Federal Reserve Bank Questions and Answers
Monetary policy in the United States is shaped by the Federal Reserve Bank (Fed). The Federal Reserve has two missions: achieving price stability and promoting full employment. The primary tool for achieving these goals is adjusting interest rates. When prices rise too quickly and inflation is above the Fed’s 2% target, it raises interest rates, which increases borrowing costs throughout the economy. This causes the US dollar (USD) to strengthen because it makes the United States a more attractive place for international investors to park their money. When inflation falls below 2% or when the unemployment rate is very high, the Fed may lower interest rates to encourage borrowing, which affects the dollar.
The Federal Reserve (Fed) holds eight policy meetings annually, where the Federal Open Market Committee (FOMC) assesses economic conditions and makes monetary policy decisions. The FOMC meeting is attended by twelve Fed officials – the seven members of the Board of Governors, the New York Fed president, and four of the remaining eleven regional Fed presidents, who serve one-year terms on a rotating basis.
In extreme cases, the Fed may resort to a policy called quantitative easing (QE). Quantitative easing is the process by which the Federal Reserve dramatically increases the flow of credit into a stuck financial system. It is a non-standard policy measure used during crises or when inflation is very low. It was the Fed’s weapon of choice during the Great Financial Crisis of 2008. It involves the Fed printing more dollars and using them to buy high-quality bonds from financial institutions. Quantitative easing usually weakens the US dollar.
Quantitative tightening (QT) is the reverse process of quantitative easing, where the Fed stops purchasing bonds from financial institutions and does not reinvest capital from bonds it holds outstanding, to purchase new bonds. This is usually positive for the value of the US dollar.
