United States Dollar Index holds onto Monday’s gains near 99.70 ahead of Fed’s policy
- The US Dollar Index clings to gains near 99.70 in the countdown to the two-day Fed meeting.
- Investors expect the Fed to leave interest rates unchanged in the 3.50%-3.75% range.
- The US and Iran sign a peace framework, which restricts Tehran from building nuclear weapons.
The US Dollar (USD) trades firmly near Monday’s high ahead of the start of the two-day Federal Reserve’s (Fed) monetary policy meeting, whose decision will be announced on Wednesday. As of writing, the US Dollar Index (DXY), which tracks the Greenback’s value against six major currencies, clings to Monday’s gains near 99.70.
The impact of the Fed’s monetary policy decision and the interest rate guidance will be significant on the US Dollar, being the first under the new Chairman, Kevin Warsh.
Investors expect the Fed to hold interest rates steady in the 3.50%-3.75% range as the United States (US) inflation has accelerated significantly in the past few months due to elevated energy prices in the wake of Middle East tensions.
However, the signing of a peace framework between the US and Iran on Monday and an eventual reopening of the Strait of Hormuz has put some anchoring on inflation expectations, experts warned some more inflation pain in the near future as normal trading won’t return anytime soon.
Meanwhile, investors await the details of “a page and a half” document signed between the US and Iran to confirm whether the Hormuz remains toll-free or not. Iran had long demanded recognition of its authority near the Hormuz to start charging tolls from ships passing by.
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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