The US Dollar Index (DXY), which measures the value of the US Dollar (USD) against six major currencies, is losing ground after three days of gains and is trading around 98.60 during Asian hours on Monday. Traders await the US third-quarter GDP report on Tuesday, which will provide insight into the economic health and timing of the Federal Reserve’s next interest rate moves.
The US dollar may regain strength due to dovish sentiment surrounding the Fed’s policy outlook. Cleveland Fed President Beth Hammack said Sunday that monetary policy is well positioned to pause and assess the effects of 75 basis point interest rate cuts on the economy during the first quarter, according to Bloomberg.
The CME FedWatch tool indicated a 79.0% probability of holding interest rates at the Fed’s January meeting, up from 75.6% the week before. Meanwhile, the probability of a 25 basis point rate cut fell to 21.0% from 24.4% a week ago.
The University of Michigan reported Friday that its consumer confidence index was revised down to 52.9 in December from the previous 53.3. The consumer expectations index fell to 54.6 from 55.0. Meanwhile, one-year inflation expectations were revised to 4.2% from 4.1% in both the initial estimate and the previous month.
Traders are also focusing on additional comments from US President Donald Trump, who said last week that the next head of the Federal Reserve (Fed) will be someone who believes in much lower interest rates. Meanwhile, Fed Governor Christopher Waller, who is under consideration for the role, said: “Given that inflation is still high, we can take our time – there is no rush to get down. We can steadily lower interest rates towards neutral.”
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.
