US Dollar strengthens aboove 98.50 despite cooling inflation data
- US Dollar Index gains ground to around 98.55 in Friday’s early European session.
- US CPI rose 2.7% YoY in November, softer than expected.
- Cooling US inflation could pave the way for Fed rate cuts.
The US Dollar Index (DXY), an index of the value of the US Dollar (USD) measured against a basket of six world currencies, trades on a positive note near 98.55 during the early European trading hours on Friday. The DXY recovers some lost ground amid the cautious mood in the market. The University of Michigan Consumer Sentiment Index and UoM Consumer Inflation Expectations data will be the highlights later on Friday.
The US Dollar rebounds from the 11-week lows as traders turn cautious. However, the potential upside for the DXY might be limited due to prospects for more Federal Reserve (Fed) rate cuts in 2026 amid signs of a weakening US labour market and soft inflation.
US inflation, as measured by the Consumer Price Index (CPI), eased to 2.7% in November, according to the US Bureau of Labor Statistics (BLS) on Thursday. This reading came in below the market consensus of 3.1%. Meanwhile, US core CPI, which excludes volatile food and energy prices, rose by 2.6%, missing the expectation of 3.0%. This figure marks the slowest pace since 2021.
The softer than expected US inflation report has fueled speculation that the US central bank might cut interest rates sooner than previously expected. This, in turn, could exert some selling pressure on the Greenback in the near term.
Financial markets are pricing in only a 26.6% probability the Fed will reduce interest rates at its next meeting in January, after it cut them by a quarter-point at each of its last three meetings, according to the CME FedWatch tool.
US Dollar FAQs
The US Dollar (USD) is the official currency of the United States of America, and the ‘de facto’ currency of a significant number of other countries where it is found in circulation alongside local notes. It is the most heavily traded currency in the world, accounting for over 88% of all global foreign exchange turnover, or an average of $6.6 trillion in transactions per day, according to data from 2022. Following the second world war, the USD took over from 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 went away.
The most important single factor impacting on the value of the US Dollar is monetary policy, which is shaped by the Federal Reserve (Fed). The Fed has two mandates: to achieve price stability (control inflation) and foster full employment. Its primary tool to achieve these two goals is by adjusting interest rates. When prices are rising too quickly and inflation is above the Fed’s 2% target, the Fed will raise rates, which helps the USD value. When inflation falls below 2% or the Unemployment Rate is too high, the Fed may lower interest rates, which weighs on the Greenback.
In extreme situations, the Federal Reserve can also print more Dollars and enact quantitative easing (QE). QE is the process by which the Fed substantially increases the flow of credit in a stuck financial system. It is a non-standard policy measure used when credit has dried up because banks will not lend to each other (out of the fear of counterparty default). It is a last resort when simply lowering interest rates is unlikely to achieve the necessary result. It was the Fed’s weapon of choice to combat the credit crunch that occurred during the Great Financial Crisis in 2008. It involves the Fed printing more Dollars and using them to buy US government bonds predominantly from financial institutions. QE usually leads to a weaker US Dollar.
Quantitative tightening (QT) is the reverse process whereby the Federal Reserve stops buying bonds from financial institutions and does not reinvest the principal from the bonds it holds maturing in new purchases. It is usually positive for the US Dollar.
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