The US Dollar Index (DXY) is currently trading at 104.12, remaining rather neutral. Markets stand largely quiet as the week's highlight is the release of March’s US Consumer Price Index (CPI) figures on Wednesday. In the meantime, declining US Treasury yields seem to be weakening the US Dollar, and minor data releases have failed to trigger a significant reaction.
The data will continue fueling expectations for the Fed's easing cycle and as for now is seen starting in June. Amid two months of high inflation, the Fed revised its projections upward, but Jerome Powell confirmed a complacent attitude toward these figures. Consequently, the US Dollar remains in suspense, awaiting potential policy shifts tied to incoming data. Last week’s hot labor market figures may set the tone for a more hawkish Fed if inflation comes in higher than expected.
On the daily chart, the static position of the Relative Strength Index (RSI) indicates neutral momentum, while the appearance of a fresh red bar in the Moving Average Convergence Divergence (MACD) histogram signals a potential shift toward bearish momentum in the short term.
On the other hand, the DXY is experiencing some bullish resilience, as evidenced by its stance above the 20, 100, and 200-day Simple Moving Averages (SMAs). The current positioning of DXY suggests that the buying force is still dominating with a defensive line held by the bulls, keeping the DXY above these significant SMAs.
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.