The US Dollar Index (DXY), which measures the value of the US Dollar (USD) against six major currencies, remains steady and trades around the 98.00 level during Asian hours on Tuesday. Traders will likely focus on the minutes of the December Federal Open Market Committee (FOMC) meeting scheduled for later today, to gain insight into the Fed’s outlook for 2026.
The dollar may face challenges amid continued expectations of two additional interest rate cuts by the Fed in 2026. The CME FedWatch tool shows an 83.9% probability of holding interest rates at the Fed’s January meeting, up from 80.1% the week before. Meanwhile, the probability of a 25 basis point rate cut fell to 16.1% from 19.9% a week ago.
The US central bank cut interest rates by 25 basis points at the December meeting, bringing the target range to 3.50% – 3.75%. The Fed cut cumulative interest rates by 75 basis points in 2025 amid a cool labor market and still-high inflation.
Risk appetite is deteriorating amid ongoing geopolitical risks. Uncertainty has also returned over efforts to end the war in Ukraine, with the Russian Foreign Minister saying Moscow’s negotiating position will change after alleged strikes on President Putin’s residence.
In the Middle East, Saudi air strikes in Yemen and Iran’s declaration of a “full-scale war” with the United States, Europe and Israel have raised fears of wider instability, with Trump warning of more strikes if Iran resumes rebuilding its nuclear programme.
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.
