• AUD/USD jumps to over a one-week high in reaction to the RBA’s surprise 25 bps rate hike.
• The emergence of some USD dip-buying and a softer risk tone cap the risk-sensitive Aussie.
• The uncertainty over the Fed’s rate-hike path warrants some caution for aggressive traders.

The AUD/USD pair retreats a few pips from over a one-week high touched earlier this Tuesday and trades just below the 0.6700 mark during the first half of the European session, still up over 1% for the day.

The Australian Dollar (AUD) strengthens across the board in reaction to the Reserve Bank of Australia’s (RBA) surprise 25 bps rate hike and hawkish outlook. In fact, the Australian central bank indicated that some further tightening of monetary policy may be required to ensure that inflation returns to target in a reasonable timeframe. This, in turn, prompts an aggressive short-covering rally around the AUD/USD pair, though the momentum loses steam near the 0.6715 area.

The US Dollar (USD) reverses an intraday dip and holds steady near a two-week high set earlier this Tuesday amid expectations for additional 25 bps lift-off at the end of the two-day FOMC monetary policy meeting on Wednesday. The bets were reaffirmed by the US ISM PMI report released on Monday, which showed that business activity in the manufacturing sector pulled off a three-year low in April and that there was a build-up of inflation pressures last month.

The prospects for further policy tightening by the Federal Reserve (Fed), meanwhile, add to worries about economic headwinds stemming from rising borrowing costs. This, in turn, tempers investors’ appetite for riskier assets, which is evident from a softer tone around the equity markets. The anti-risk flow further benefits the Greenback’s relative safe-haven status and contributes to keeping a lid on any further gains for the AUD/USD pair, at least for the time being.

The markets, however, now expect that the US central bank will signal a pause in its rate-hiking cycle beyond May. This might hold back the USD bulls from placing aggressive bets and continue to act as a tailwind for the AUD/USD pair ahead of the highly-anticipated FOMC decision, scheduled to be announced on Wednesday. In the meantime, traders on Tuesday will take cues from the release of the US JOLTS Job Openings data, due later during the early North American session.