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 negatively near 99.60 during Asian trading hours on Wednesday. The DXY index continues to decline as traders expect US interest rates to be cut in December.
Weaker-than-expected US economic data released on Tuesday boosted expectations of an interest rate cut by the US Federal Reserve next month, broadly undermining the US dollar. Data from the US Census Bureau showed that US retail sales rose 0.2% month-on-month in September, versus a 0.6% rise previously. This figure was weaker than the estimate of 0.4%.
Meanwhile, the US Producer Price Index rose 2.7% year-on-year in September, compared to 2.7% in August (revised from 2.6%), in line with expectations. Core PPI rose 2.6% y/y in September versus 2.9% previously (revised from 2.8%), lower than expected at 2.7%.
Furthermore, additional signs of weakness in the US labor market are contributing to the DXY’s downward trend. Automatic Data Processing (ADP) revealed on Tuesday that private sector employers lost an average of 13,500 jobs for the four weeks ending November 8, compared to the previous reading of -2.5 thousand.
US durable goods orders, weekly initial jobless claims, Chicago Purchasing Managers’ Index (PMI), and Fed’s Beige Book will be in focus later on Wednesday. In case of stronger than expected results, this could push the DXY index higher 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 weakens 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.
