The US Dollar Index (DXY) eases slightly on Wednesday as it becomes increasingly clear that markets won the arm wrestling match with the US Federal Reserve (Fed). The recent upward moves in both US bond yields and the US Dollar were enough to twist the arm of US Fed Chairman Jerome Powell. Powell said on Tuesday that recent data shows a lack of further progress in taming inflation, and that it will take longer before having enough confidence that price growth is coming down to target before considering the first rate cut.
On the economic data front, no market-moving data is expected besides some second-tier numbers. More importantly, Fed speakers will take the stage right at the end of the US session, with Federal Reserve Bank of Cleveland President Loretta Mester and Federal Reserve Governor Michelle Bowman to speak.
The US Dollar Index (DXY) eases a touch on Wednesday. With Fed Chairman Powell confirming that it will take longer than expected to start lowering interest rates, some unwinding of the rally that took place in the DXY since last week’s Consumer Price Index numbers is likely. Expect a bit of a pullback, although the substantial wider rate differential between higher US rates and the rest of the world should keep the DXY at higher levels above 104.00.
On the upside, the fresh high of Tuesday at 106.52 is the level to beat first. Further up and above the 107.00 round level, the DXY Index could meet resistance at 107.35, the October 3 high.
On the downside, the first important level is 105.88, a pivotal level since March 2023, which proved its importance on Monday by holding as a support. Further down, 105.12 and 104.60 should also act as a support ahead of the region with both the 55-day and the 200-day Simple Moving Averages (SMAs) at 104.17 and 103.91, respectively.
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.