The US Dollar Index (DXY), an index of the value of the US Dollar (USD) measured against a basket of six global currencies, is trading flat near 98.00 during early European trading hours on Monday. Financial markets are expected to trade on thin volumes as traders prepare for the New Year holiday. The US Pending Home Sales report for November is scheduled for release later Monday.
The US Federal Reserve cut the federal funds rate by 25 basis points at its December policy meeting, bringing the target range to 3.50%-3.75%. The Fed cut cumulative interest rates by 75 basis points in 2025. Markets are pricing in at least two rate cuts by the US central bank in 2026 amid a cool labor market and easing inflation, which could weigh on the US dollar versus its rivals.
Financial markets expect a roughly 18.3% chance that the Fed will cut interest rates at its next policy meeting in January, according to the CME FedWatch tool.
US President Donald Trump said last week that he wants the next Fed head to cut interest rates if markets do well. His comments are likely to heighten concerns among investors and policymakers about the Fed’s independence. This, in turn, could drag the DXY down.
On the other hand, geopolitical risks and uncertainties could boost safe haven flows, supporting the US dollar. Trump said Sunday that he has made “a lot of progress” in talks with Ukrainian President Volodymyr Zelensky on a potential peace deal, but it could take a few weeks to get done and there is no set timeline.
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.
