101.70 area: US Dollar Index (DXY) holds steady ahead of US CPI report amid uncertainty over Iran

Supportive factors help DXY steady after its overnight decline.
Conflicting US-Iran peace talk signals sustain the geopolitical risk premium.
Ahead of US CPI, Fed rate hike expectations lend the USD additional support.

101.70 is the consolidation area for the US Dollar Index (DXY) in Tuesday's Asian session. The index, which measures the Greenback against a currency basket, is awaiting fresh developments in the Middle East crisis and US consumer inflation data.

Describing the conflict as effectively over, US President Donald Trump said there was positive momentum towards ending the war on Iran and that renewed strikes were quite unlikely. A contrasting message came from Mohsen Rezaei, Secretary of Iran’s Supreme National Security Council. He rejected reports of active negotiations as fake news and repeated that Washington must accept Tehran's seven conditions for ending the conflict. The resulting geopolitical risk premium continues to underpin the safe-haven US Dollar (USD).

TMGM Analysis: Financial Market News, Economic Calendar & Market Insights

Rate expectations also favour the DXY. Last Friday's strong US Nonfarm Payrolls (NFP) report reinforced market bets on an imminent interest rate increase by the US Federal Reserve (Fed). Traders now assign a probability of over 80% to another rise in borrowing costs in December, according to the CME Group's FedWatch Tool. Despite this support, DXY bulls are holding off on fresh positions until the US Consumer Price Index (CPI) report is released.

Investors will scrutinise the key inflation figures for further indications of the Fed's policy trajectory. Geopolitical news will also be a major driver of near-term USD movements and could give the DXY meaningful impetus. Until then, the fundamental backdrop outlined above calls for caution among bearish traders considering positions for further declines.

Inflation: Key Questions

How is inflation measured?

A rise in the cost of a representative basket of goods and services is measured as inflation. The headline rate is generally reported as a percentage change month-on-month (MoM) and year-on-year (YoY). By contrast, core inflation strips out more volatile components, including food and fuel, whose prices can shift with geopolitical events and seasonal factors. Economists concentrate on this core measure. It is also the measure targeted by central banks, whose mandate is to maintain inflation at a manageable level, typically around 2%.

Consumer Price Index (CPI): What does it measure?

Changes in the prices of a basket of goods and services over time are tracked by the Consumer Price Index (CPI). These changes are generally presented as month-on-month (MoM) and year-on-year (YoY) percentages. Central banks target Core CPI, which removes volatile food and fuel components. A Core CPI reading above 2% typically leads to higher interest rates; a reading below 2% usually has the reverse effect. Higher rates support a currency, so rising inflation generally strengthens it. Falling inflation tends to have the opposite effect.

Inflation and foreign exchange: What is the link?

A country's currency tends to strengthen when inflation is high and weaken when inflation is low, however counter-intuitive that may appear. To contain higher inflation, the central bank will normally increase interest rates. Those higher rates draw in more global capital from investors seeking attractive returns on their funds.

Inflation and Gold prices: How do they interact?

Historically, investors sought Gold during periods of high inflation because it retained its value. They still often buy Gold for its safe-haven qualities during extreme market turbulence, but this is not the prevailing pattern most of the time. High inflation prompts central banks to raise interest rates to bring price pressures under control. For Gold, higher rates are a negative: they raise the opportunity cost of holding the metal rather than an interest-bearing asset or a cash deposit. Conversely, lower inflation tends to support Gold by bringing interest rates down, making the metal a more attractive investment alternative.