The US Dollar Index (DXY), an index of the value of the US Dollar (USD) measured against a basket of six world currencies, currently trades near 99.70 in the Asian trading hours on Monday. The DXY declines amid improved risk sentiment. Traders brace for the release of the US ISM Manufacturing Purchasing Managers Index (PMI) report, which will be released later on Monday.
US President Donald Trump said on Sunday that he had called off an attack on Iran and that talks between the two sides would happen on Monday. Trump suggested an agreement on reopening the Strait of Hormuz may be close and added that he would also continue to pursue a path to end Iran’s nuclear program.
Hopes of a breakthrough between Washington and Tehran could undermine a safe-haven currency such as the US Dollar against its rivals in the near term.
All eyes will be on the US employment data on Friday. This report could offer some hints on the health of the labor market. Economists expect Nonfarm Payrolls (NFP) to increase by 91,000 in July, while the Unemployment Rate is projected to rise to 4.3% during the same period. In case of stronger-than-expected outcomes, this could help limit the DXY’s losses.
The Federal Reserve (Fed) held the interest rates unchanged at its July policy meeting last week. Markets have priced in nearly a 64.7% chance of a US rate hike in September, down from about 77% before the July Fed meeting, according to the CME FedWatch tool.
Dollar seen under renewed pressure as Fed rate expectations fade
According to analysts at Commerzbank, the Dollar is likely to come back under pressure once tensions with Iran subside, as they judge that the Fed is “unlikely to raise rates as markets have priced in.” In their view, the easing of geopolitical risk would remove a key support for the currency, leaving it more vulnerable to disappointment on the US rate path.
US Dollar FAQs
The US Dollar (USD) is the official currency of the United States of America, and the ‘de facto’ currency of a significant number of other countries where it is found in circulation alongside local notes. It is the most heavily traded currency in the world, accounting for over 88% of all global foreign exchange turnover, or an average of $6.6 trillion in transactions per day, according to data from 2022.
Following the second world war, the USD took over from the British Pound as the world’s reserve currency. For most of its history, the US Dollar was backed by Gold, until the Bretton Woods Agreement in 1971 when the Gold Standard went away.
The most important single factor impacting on the value of the US Dollar is monetary policy, which is shaped by the Federal Reserve (Fed). The Fed has two mandates: to achieve price stability (control inflation) and foster full employment. Its primary tool to achieve these two goals is by adjusting interest rates.
When prices are rising too quickly and inflation is above the Fed’s 2% target, the Fed will raise rates, which helps the USD value. When inflation falls below 2% or the Unemployment Rate is too high, the Fed may lower interest rates, which weighs on the Greenback.
In extreme situations, the Federal Reserve can also print more Dollars and enact quantitative easing (QE). QE is the process by which the Fed substantially increases the flow of credit in a stuck financial system.
It is a non-standard policy measure used when credit has dried up because banks will not lend to each other (out of the fear of counterparty default). It is a last resort when simply lowering interest rates is unlikely to achieve the necessary result. It was the Fed’s weapon of choice to combat the credit crunch that occurred during the Great Financial Crisis in 2008. It involves the Fed printing more Dollars and using them to buy US government bonds predominantly from financial institutions. QE usually leads to a weaker US Dollar.
Quantitative tightening (QT) is the reverse process whereby the Federal Reserve stops buying bonds from financial institutions and does not reinvest the principal from the bonds it holds maturing in new purchases. It is usually positive for the US Dollar.
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