The US Dollar Index (DXY), a measure of the value of the USD against a basked of six other currencies, lost its ground after the release of mixed inflation data for August. Despite a decline in the overall inflation rate to 2.5% on an annual basis, the core Consumer Price Index (CPI) remained steady at 3.2%, indicating persistent inflationary pressures. This data has dampened expectations of a 50-basis-point interest rate cut by the Federal Reserve (Fed) in September, increasing the likelihood of a more modest 25-basis-point reduction.
Based on economic indicators, the US economy remains robust, surpassing expectations. While the market anticipates further monetary relaxation, it is essential to temper expectations. The current growth trajectory is unlikely to warrant such aggressive easing measures. It is crucial to adopt a balanced approach, acknowledging both the economy's strength and the need for cautious optimism in decision-making.
Technical analysis for the DXY index shows that indicators are currently in a negative territory but seem to have flattened. However, the index managed to regain the 20-day Simple Moving Average (SMA) at around 101.60 on Tuesday, which improved the short-term outlook.
The Relative Strength Index (RSI) and the Moving Average Convergence Divergence (MACD) are both flat in negative terrain, which suggests that there is no bearish threat. That being said, on Wednesday, the upside appeared to be limited, but buyers have more room to continue advancing.
Key support levels include 101.60, 101.30 and 101.00, while resistance levels include 101.80, 102.00 and 102.30.
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.