Inflation Scare – What Will Happen to the Forex Markets?

Introduction

One major factor that induces strong volatility in the forex market is the inflation reports. An increasing inflation rate reduces the value of the currency in the foreign exchange market. An increasing inflation rate moves the Central Banks to take aggressive steps and increase the interest rate to attract investors.  Hiking the interest rate for a given currency attracts investors and causes strong volatility for the currency. The rising inflation rate for the US dollar since 2022 has had a high impact on the forex market so far,  as it pushed the Fed to take aggressive steps towards hiking the interest rate. 

Hiking the interest rate for the US dollar up to the present level of 4.0% had hitherto raised the value of the US dollar against other pairs matched with it in the market. Almost all currency pairs matched with the US dollar as their counter currency reached a new low in 2022 when the dollar index (DXY) rose to a new high at $114.780. EURUSD for instance fell to a new low at $0.95340 before recovering again. 

This work will therefore help you understand the effects of inflation scares on the forex market and how inflation affects the exchange rate of various currency pairs in the forex market today. 

What is inflation? 

Almost all traders today have suffered the menace of inflation in the market and so it becomes easy to define inflation to the beginner. Inflation is when the prices of goods and services in the market increase drastically as a result of having a high amount of that currency in circulation. Often when traders have so much money in their hands to spend, they tend to purchase more goods and services without bargaining so much for them. This creates more demands for such products causing the suppliers to increase their prices. With prices increasing as a result of high demand, the purchasing power of the currency reduces too, and this is exactly what we call inflation. 

Understanding the forex market

The forex market is the largest financial market in the world today which provides the meeting point for traders to exchange different currencies as well as other valuable products at the market prices. The advent of online brokers today has made forex trading an easy investment package. Investors can now transact with other traders in the forex market from the comfort of their homes using their smartphones. With CFD forex brokers it is now possible to trade forex anywhere using the internet. 

What effects will the inflation scare have on the forex market?

The rising global inflation rate has had so much impact on the forex market since 2022. With the US dollar attaining its highest inflation rate ever, over forty years at 9.1% in June 2022, the Fed was pushed to take more aggressive actions to bring down the inflation rate, and continued hiking its interest rate up to the sixth consecutive time, to bring the interest rate presently at 4.0%. 

This has caused so much volatility in the forex market, causing the dollar index to rise to two decades high at 114.780. This has crashed the prices of all assets pegged to the US dollar in the forex market including: Stocks, Commodities, Crypto, and other currency pairs having the US dollar as their counter pairs. 

As a result of the inflation scare which has decreased the exchange rates of most currency pairs in the market today, the forex market will be expected to remain volatile till the interest rate hiking cycle is halted.