AUD/USD refreshes daily low amid softer risk tone, downside seems limited

• AUD/USD comes under some selling pressure on Monday and hits a fresh daily low in the last hour.
• A weaker tone around the equity markets is seen exerting pressure on the risk-sensitive Aussie.
• Bets for smaller Fed rate hikes keep the USD depressed and should help limit losses for the major.

The AUD/USD pair attracts some sellers following an early uptick to the 0.7120 area on Monday and remains on the defensive through the early European session on Monday. Spot prices drop to a three-day low, around the 0.7075 region in the last hour, though any meaningful downside still seems elusive.

A softer risk tone - as depicted by a weaker trading sentiment around the equity markets - is seen as a key factor driving flows away from the risk-sensitive Aussie. Despite China's move to scale back its strict zero-COVID policy in December, the worst yet COVID-19 outbreak in the country has been fueling uncertainty about a strong economic recovery. This, in turn, tempers investors' appetite for riskier assets and keeps a lid on any optimism in the markets.

The downside for the AUD/USD pair, meanwhile, is likely to remain cushioned, at least for now, amid subdued US Dollar price action. In fact, the USD Index, which tracks the Greenback against a basket of currencies, languishes near a nine-month low amid firming expectations for a less aggressive policy tightening by the Fed. The markets seem convinced that the US central bank will soften its hawkish stance and expect a smaller 25 bps rate hike on Wednesday.

The bets were lifted by Friday's release of the US Personal Consumption Expenditures (PCE) data, which showed that the Core PCE Price Index fell to the 4.4% YoY rate in December from the 4.7% previous. That said, other US macro data released recently pointed to a resilient economy and backed the case for the Fed to maintain its hawkish stance for longer. Hence, the focus will remain on the outcome of a two-day FOMC meeting, which might provide cues on future rate hikes.

Heading into the key central bank event risk, traders might refrain from placing aggressive bets and prefer to move to the sidelines. Apart from this, rising odds for an additional rate hike by the Reserve Bank of Australia (RBA) in February could underpin the Australian dollar and help limit any meaningful corrective pullback for the AUD/USD pair. This makes it prudent to wait for strong follow-through selling before confirming that spot prices have topped out.

Technical levels to watch