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 lower near 98.15 during Asian trading hours. Traders are preparing for US economic data this month to gauge the path of interest rates.
Concerns about the independence of the Federal Reserve under the administration of US President Donald Trump may undermine the US dollar against its rivals. Traders believe Trump will appoint a dovish successor to Fed Chairman Jerome Powell, whose term ends in May, after the US president repeatedly criticized Powell last year for not cutting interest rates faster or deeper.
“We expect concerns about central bank independence to extend into 2026, and we see the upcoming change in Fed leadership as one of many reasons why the risks surrounding our federal funds rate outlook lean toward dovish,” Goldman Sachs strategists said.
Financial markets are pricing in two interest rate cuts this year compared to the cut expected by a divided Fed. According to the CME FedWatch tool, financial markets expect a roughly 15.0% probability that the US central bank will cut interest rates at its next meeting in January.
Attention will turn to key US economic data, including US nonfarm payrolls and unemployment rate data, which will be published next week. These reports could provide some hints about the health of the labor market and US interest rates this year. If US employment data shows a stronger than expected result, this could help limit the dollar index’s losses in the near term.
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.
