United States Dollar Index posts modest gains to near 100.00 amid rising Middle East tensions

US Dollar Index trades in positive territory around 100.00 in Wednesday’s Asian session.
Escalating tensions in the Middle East boost the US Dollar.
The US May CPI inflation data will be the highlight later on Wednesday.

Lallalit Srijandorn FXStreet

The US Dollar Index (DXY), an index of the value of the US Dollar (USD) measured against a basket of six world currencies, currently trades near 100.00 during the Asian trading hours on Wednesday. The DXY trades with mild gains amid rising tensions in the Middle East after the United States (US) launched strikes on Iran to retaliate for the downed helicopter. The US inflation report will take center stage later in the day.

Iran’s Islamic Revolutionary Guard Corps (IRGC) said it attacked the US Fifth Fleet in Bahrain with drones in response to US strikes on areas in southern Iran, adding that strikes are continuing. Iran's revolutionary guards on Wednesday said that they targeted the Ali Al Salem base in Kuwait with drones and also targeted a US base in Jordan with a missile attack.

Earlier Wednesday, the US launched a new wave of strikes on Iran in what it called a proportional response to the shooting down of a US helicopter gunship near the Strait of Hormuz a day earlier. Fears of wider war in the Middle East could boost the US Dollar as a safe-haven currency.

Traders brace for the US Consumer Price Index (CPI) inflation data for more cues about the US interest rate path. Any signs of hotter inflation in the US could lead traders to price in a higher probability of the Federal Reserve (Fed) raising interest rates, which underpin the DXY.

Markets are now pricing in a 47% chance of a quarter-point rate hike in December, up from just about 14% a month ago, according to the CME FedWatch tool.

Inflation FAQs

What is inflation?

Inflation measures the rise in the price of a representative basket of goods and services. Headline inflation is usually expressed as a percentage change on a month-on-month (MoM) and year-on-year (YoY) basis. Core inflation excludes more volatile elements such as food and fuel which can fluctuate because of geopolitical and seasonal factors. Core inflation is the figure economists focus on and is the level targeted by central banks, which are mandated to keep inflation at a manageable level, usually around 2%.

What is the Consumer Price Index (CPI)?

The Consumer Price Index (CPI) measures the change in prices of a basket of goods and services over a period of time. It is usually expressed as a percentage change on a month-on-month (MoM) and year-on-year (YoY) basis. Core CPI is the figure targeted by central banks as it excludes volatile food and fuel inputs. When Core CPI rises above 2% it usually results in higher interest rates and vice versa when it falls below 2%. Since higher interest rates are positive for a currency, higher inflation usually results in a stronger currency. The opposite is true when inflation falls.

What is the impact of inflation on foreign exchange?

Although it may seem counter-intuitive, high inflation in a country pushes up the value of its currency and vice versa for lower inflation. This is because the central bank will normally raise interest rates to combat the higher inflation, which attract more global capital inflows from investors looking for a lucrative place to park their money.

How does inflation influence the price of Gold?

Formerly, Gold was the asset investors turned to in times of high inflation because it preserved its value, and whilst investors will often still buy Gold for its safe-haven properties in times of extreme market turmoil, this is not the case most of the time. This is because when inflation is high, central banks will put up interest rates to combat it. Higher interest rates are negative for Gold because they increase the opportunity-cost of holding Gold vis-a-vis an interest-bearing asset or placing the money in a cash deposit account. On the flipside, lower inflation tends to be positive for Gold as it brings interest rates down, making the bright metal a more viable investment alternative.

Author

Lallalit Srijandorn

FXStreet

Lallalit Srijandorn is a Parisian at heart. She has lived in France since 2019 and now becomes a digital entrepreneur based in Paris and Bangkok.

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