Australia’s manufacturing pulse softened in May, with the PMI easing to 50.7 points from 51.3 in April. While it stayed just above the expansion threshold, new and export orders weakened and cost pressures remained elevated. Input costs rose at the second-fastest pace in almost four years, and output price inflation accelerated to its highest level since August 2022. The Melbourne Institute monthly inflation gauge fell in May after two consecutive month-on-month increases, partly reflecting lower fuel prices.
Housing indicators also cooled. National home values were unchanged in May, marking the first flat month-on-month outcome since January 2025, with declines reported in Sydney and Melbourne. Markets are pricing in no more than one additional Reserve Bank of Australia hike for the rest of the year, as household sentiment and housing momentum show further caution if housing costs continue to ease.
Australian Economic Slowdown and RBA Policy Outlook
We see the Australian economy showing clear signs of slowing, with both the manufacturing and housing sectors losing momentum. This softening data supports the view that the Reserve Bank of Australia is nearing the end of its rate-hiking cycle. The combination of easing inflation gauges and a flat housing market reduces the pressure on the RBA to tighten policy further.
Given this backdrop, we believe the Australian dollar is vulnerable, especially against currencies where the central bank remains more aggressive. For instance, recent US inflation data remains firm, with core CPI holding above 3.5%, suggesting the Federal Reserve will maintain a hawkish stance for longer. This policy divergence makes selling the AUD against the USD an attractive strategy for the coming weeks.
Australian Dollar, Commodities, and Trading Strategies
Traders should consider using options to express a bearish view on the AUD. Buying AUD/USD put options with a three-month expiry allows for participation in potential downside while capping risk if Australian inflation data proves unexpectedly strong. Volatility is likely to remain elevated around key data releases, making defined-risk strategies prudent.
We also note that prices for iron ore, Australia’s key export, have recently softened, trading near $105 per tonne amid concerns over Chinese industrial demand. Historically, a sustained drop in commodity prices has weighed heavily on the Australian dollar. This external headwind reinforces our cautious outlook on the currency.
For those trading interest rates, the current market pricing of less than one full 25 basis point hike for the remainder of the year seems reasonable. We see opportunities in positioning for the RBA to remain on hold through the second half of 2026. This can be expressed by receiving fixed rates in the swaps market or through futures that profit from stable or falling short-term rates.
