Canadian Dollar trims gains, US Dollar firms up ahead of US CPI numbers
- USD/CAD edges up to levels right above 1.3930 as markets brace for US CPI data.
- The US Dollar is drawing support from higher demand for safety as hopes of a swift end to the US-Iran war fade.
- Canadian Dollar dips remain shallow amid rising Oil prices.
Canadian Dollar (CAD) ticks down from two-month highs as the US Dollar (USD) firms up across the board, with investors bracing for the US Consumer Price Index (CPI) report due later in the day. The USD/CAD pair has gained about 15 pips on Wednesday, returning above 1.3930, but the broader trend remains bearish after losing more than 1% in a bit over two weeks.
Investors are cutting back US short positions across the board on Wednesday, bracing for the US consumer inflation figures, which are expected to provide further insight into the Federal Reserve’s (Fed) near-term monetary policy path.
Analysts at ING note that markets are already positioned for “a softer price story” and that “we would probably need to see a 0.1% month-on-month read on core inflation (...) to drag market pricing of a September Fed rate hike away from a 50% probability in favour of no change,” This scenario should “see the Dollar soften – particularly against the procyclical currencies,” said the ING experts in a note.
Tensions in the Middle East support the safe-haven USD
The US Dollar is drawing additional support from higher safe-haven demand amid flaring tensions in the Middle East. Iran-backed Houthi militants attacked an Egyptian vessel in the Red Sea, killing some crew members, after the US Army opened fire against a cargo ship attempting to break the blockade of Iranian ports, pushing back hopes of the reopening of the Strait of Hormuz and a swift end to the war.
The Canadian Dollar, on the other hand, remains supported by higher Oil prices, which are acting as headwinds for USD/CAD rallies. Oil is Canada’s main export, and the Canadian Dollar has appreciated nearly 2% since the US broke the first ceasefire in early July.
Inflation FAQs
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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