The US Dollar Index (DXY) hovered cautiously around 99.90 on Tuesday, as markets positioned ahead of Wednesday’s US Consumer Price Index (CPI) release, where inflation is expected to edge higher in May. Earlier weakness in the dollar was pared after US President Donald Trump said Iran had shot down a US Apache helicopter over the Strait of Hormuz and that the US “must respond to this attack”. In subsequent moves, oil and gold came under pressure, with gold slipping below $4,250 and later trading near $4,260 even as softer US Treasury yields and a weaker greenback would typically support non-yielding assets.
In G10 FX, EUR/USD traded near 1.1550 with attention on US CPI, while the European Central Bank (ECB) is expected to raise rates on Thursday. GBP/USD pushed towards 1.3390, and USD/JPY sat around 160.30, up 0.15% and close to levels associated with intervention risk. AUD/USD eased towards 0.7030 after weak Westpac Consumer Confidence data. In commodities, WTI crude traded near $87.90 per barrel as traders assessed potential Middle East disruption. The diary includes Japan PPI, US CPI and the US Federal Budget Balance on Wednesday; UK monthly GDP and US PPI, plus US Core PPI and initial jobless claims on Thursday; and US Michigan sentiment and inflation expectations alongside China’s new loans and M2 money supply on Friday.
Inflation Expectations and Volatility in Asset Classes
With the US Consumer Price Index report due today, we are bracing for significant volatility across asset classes. The market is positioned for a hot inflation number, which would put pressure on the Federal Reserve and likely boost the dollar. We are using options to prepare for a sharp move in either direction, as even a small deviation from consensus can trigger a major repricing, much like the market swings seen after the May 2024 CPI print came in slightly cooler than expected at 3.3%.
The geopolitical situation in the Middle East adds a layer of complexity and supports a stronger dollar as a safe-haven asset. This is a classic flight-to-safety move, reminiscent of the dollar’s rally in early 2022 following the escalation of conflict in Eastern Europe. For now, we are treating this as a short-term catalyst that favors holding long dollar positions or using VIX call options to hedge against sudden escalations.
Interest Rates, Gold Reaction, and Policy Divergence
Gold’s strange weakness, despite these tensions, tells us the market is more focused on interest rates than on geopolitical risk. With the 10-year Treasury yield currently holding above 4.25%, the opportunity cost of holding non-yielding gold is very high, especially at a price above $4,200 an ounce. We think a hot CPI number will send real yields higher and could push gold down further, making puts on gold ETFs an attractive hedge.
There is a clear policy split between the European Central Bank, which is expected to hike rates on Thursday, and the Fed, which is waiting for today’s data. This divergence continues to support the Euro, keeping EUR/USD elevated near 1.1550. We favor EUR/USD call options, as a soft US CPI print could accelerate this pair’s move higher by weakening the dollar while ECB rate expectations remain firm.
Finally, we are on high alert with USD/JPY trading above 160, a level that triggered direct market intervention by Japanese authorities in 2024. The risk of a sudden, sharp drop of several hundred pips orchestrated by the Bank of Japan is extremely high. We see holding long positions here as exceptionally risky and believe buying cheap, out-of-the-money put options is a prudent way to position for a surprise intervention.
