The US Dollar (USD) is still stuck in a range while markets are puzzling to see where to go next. Several moving parts are in the mix with US economic data starting to show a very mixed picture with several data points in contraction while the labour market remains very tight. Add to that the World Economic Forum taking place in Davos, while at the same time Israel, Gaza, Red Sea, Yemen, Ukraine and Russia remain the hot topics smouldering in the background.
On the economic data front focal points this week will be Wednesday and Friday, while traders enjoy a day off on Monday. With Martin Luther King Day, the US trading session will be moving on very low volumes. Wednesday traders will gear up for US retail sales and on Friday the University of Michigan will tell markets more on the Consumer Sentiment.
The US Dollar Index (DXY) is starting to develop a pattern for 2024, and it looks to be completely different from 2023. The economic data points are not moving the needle anymore like they did in 2023, with rather macroeconomic news to drive the DXY either up or down. The overnight outcome of the Iowa Primary, which counts as a litmus test for the Presidential Elections in November, could send the DXY off in a direction that will build up all the way back to November levels.
The first level on the upside to watch is 102.70, which falls nearly in line with the trend line from the top of October 3 and December 8. If broken and closed above, the 200-day Simple Moving Average (SMA) at 103.44 comes into play. The 104.00 level might be too far off, with 103.56 (55-day SMA) coming in as the next resistance.
A rejection by the descending trendline will give fuel to Greenback bears leading to a further downturn. The line in the sand here is 101.74 – the floor which held halfway through December before breaking down in the last two weeks. In case the DXY snaps this level, expect to see a test at the low near 100.80.
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.