The US Dollar Index (DXY), an indicator of the value of the US Dollar (USD) measured against a basket of six global currencies, is trading favorably near 98.55 during early European trading hours on Friday. The DXY index is regaining some lost ground amid the cautious market mood. The University of Michigan Consumer Confidence Index and Consumer Inflation Expectations data from the University of Michigan will be the highlights later Friday.
The US dollar rebounded from 11-week lows as traders turned cautious. However, DXY’s potential upside may be limited by the prospects of further interest rate cuts by the Federal Reserve (Fed) in 2026 amid signs of a weak US labor market and subdued inflation.
U.S. inflation, as measured by the Consumer Price Index (CPI), fell to 2.7% in November, according to the U.S. Bureau of Labor Statistics (BLS) on Thursday. This reading was lower than market expectations of 3.1%. Meanwhile, the US core CPI, which excludes volatile food and energy prices, rose 2.6%, missing expectations of 3.0%. This number represents the slowest pace since 2021.
A weaker-than-expected US inflation report has sparked speculation that the US central bank may cut interest rates sooner than previously expected. This, in turn, may put some selling pressure on the US dollar in the near term.
Financial markets expect just a 26.6% chance that the Fed will cut interest rates at its next meeting in January, after cutting them by a quarter point at each of its last three meetings, according to the CME FedWatch tool.
Frequently asked questions about the US dollar
The US dollar (USD) is the official currency of the United States of America, and the “de facto” currency of a large number of other countries where it is traded alongside local banknotes. It is the world’s most traded currency, accounting for more than 88% of total global forex trading volume, or an average of $6.6 trillion in transactions per day, according to 2022 data. After World War II, the US dollar took the place of 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 disappeared.
The most important factor affecting the value of the US dollar is monetary policy, which is shaped by the Federal Reserve. The Fed has two missions: achieving price stability (controlling inflation) and promoting full employment. The basic tool for achieving these two goals is adjusting interest rates. When prices rise too quickly and inflation is above the Fed’s 2% target, the Fed will raise interest rates, which helps the value of the US dollar. When the inflation rate falls below 2% or when the unemployment rate is very high, the Fed may cut interest rates, which affects the dollar.
In extreme cases, the Fed could also print more dollars and activate quantitative easing (QE). Quantitative easing is the process by which the Federal Reserve dramatically increases the flow of credit into a stuck financial system. It is a non-standard policy measure used when credit dries up because banks will not lend to each other (due to fear of the counterparty defaulting). It is a last resort when simply lowering interest rates is unlikely to achieve the necessary result. It has been the Fed’s weapon of choice to combat the credit crunch that occurred during the Great Financial Crisis of 2008. This involves the Fed printing more dollars and using them to buy U.S. government bonds mostly from financial institutions. Quantitative easing usually leads to a weakening of the US dollar.
Quantitative tightening (QT) is the reverse process whereby the Fed stops purchasing bonds from financial institutions and does not reinvest capital from bonds it holds outstanding in new purchases. It is usually positive for the US dollar.
