The US Dollar (USD) is outmatching other currencies on Wednesday for the second day in a row with some help from US Federal Reserve (Fed) officials, who seem to have turned more hawkish. Federal Reserve Governor Michelle Bowman lit the fire on the fuzz by saying that a rate hike is still an option while she sees too many potential risks that could still drive inflation higher. Her thesis became reality just a few hours later, after neighbouring country Canada released red-hot inflation numbers.
On the economic front, a rather light calendar ahead of ThursdayÂ’s Gross Domestic Product (GDP) final estimate and FridayÂ’s Personal Consumption Expenditures (PCE) Price Index release. Still, traders will need to watch out for the Bank Stress Test report, to be published at 20:30 GMT, in which the Fed analyzes how healthy US banksÂ’ balance sheets are in case of financial market distress.Â
The US Dollar Index (DXY) is rolling for a second day in a row, and is breaking out of its sideways pattern. The DXY is now trading just below the high of May and could rally further, should upcoming US data outperform again. Clearly the recent hawkish messages from Fed officials are spooking markets in the fear of having missed out on any signals that would signal an uptick in inflation is again at hand.Â
On the upside, the first level to watch is 105.88, which triggered a rejection at the start of May and on Friday last week. Further up, the biggest challenge remains at 106.52, the year-to-date high from April 16. A rally to 107.20, a level not seen since April 2023, would need to be driven by a surprise uptick in US inflation or a sudden hawkish shift from the Fed.Â
On the downside, 105.52 is the first support ahead of a trifecta of Simple Moving Averages (SMA). First is the 55-day SMA at 105.23, safeguarding the 105.00 round figure. A touch lower, near 104.66 and 104.48, both the 100-day and the 200-day SMA form a double layer of protection to support any declines. Should this area be broken, look for 104.00 to salvage the situation.Â
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%.
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.
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.
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.
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