US Dollar Index softens below 97.50 as traders ramp up Fed rate cut bets
- US Dollar Index declines to around 97.40 in Tuesday’s early Asian session.
- The US NFP report showed US job growth plunged in August, supporting the case for a Fed rate cut.
- The US August Producer Price Index (PPI) report will take center stage later on Wednesday.
The US Dollar Index (DXY), an index of the value of the US Dollar (USD) measured against a basket of six world currencies, extends its downside to around 97.40 during the Asian session on Tuesday. The expectations of jumbo rate cuts by the US Federal Reserve (Fed) undermine the DXY. Traders will take more cues from the US August Producer Price Index (PPI) report, which is due later on Wednesday.
The US Dollar edges lower in the wake of Friday's weak US jobs report. The recent US Nonfarm Payrolls (NFP) data revealed a slowing in hiring in August, while the unemployment rate increased to its highest level since 2021, suggesting that labor market conditions in the world's largest economy are deteriorating. These reports raise expectations for Fed rate cuts.
According to the LSEG estimates, Fed funds futures are currently pricing in nearly a 90% possibility of a 25 basis points (bps) cut this month and a 10% odds of a 50 bps rate cut.
The US PPI report will be in the spotlight later on Wednesday, which is expected to show an increase of 3.3% YoY in August. Meanwhile, the core PPI is projected to show a rise of 3.5% during the same period. This report could offer some hints about the US interest rate outlook. In case of a surprise uptick in inflation, this could lift the DXY in the near term.
"We feel there's a chance for a surprise uptick in the dollar especially if the inflationary figures to arrive in the form of PPI (producer price index) and CPI (consumer price index) paint a picture in which prices are just simply getting out of control," said Juan Perez, director of trading at Monex USA in Washington.
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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