US Dollar Index posts modest gains to near 98.50, US PCE inflation data looms
- US Dollar Index gains ground to near 98.40 in Friday’s early Asian session.
- The US economy grew at a 3.8% rate in Q2; Initial Jobless Claims tumbled to 218,000 last week.
- The US August PCE inflation report will be the highlight later on Friday.
The US Dollar Index (DXY), an index of the value of the US Dollar (USD) measured against a basket of six world currencies, trades on a stronger note around 98.40 during the Asian trading hours on Friday. The DXY extends the rally to near a three-week high as stronger US economic data would likely restrain the future interest rate cuts by the Federal Reserve (Fed).
The US Gross Domestic Product (GDP) expanded at an annual rate of 3.8% in the second quarter (Q2), the US Bureau of Economic Analysis (BEA) final estimate showed on Thursday. This reading came in stronger than the previous estimate and the expectation of 3.3%. The US Dollar (USD) attracts some buyers in an immediate reaction to the encouraging US economic data.
Additionally, the US Initial Jobless Claims for the week ending September 20 declined to 218K, compared to the previous reading of 232K (revised from 231K) and below the market consensus of 235K.
Traders will assess mixed signals from Fed policymakers. Kansas City Fed President Jeffrey Schmid said the rate cut was needed to help ensure that the job market remains in a good place. Chicago Fed President Austan Goolsbee noted that he was not eager to do a lot more policy easing while inflation is above target and moving the wrong way.
Financial markets are now pricing in nearly a 43 basis points (bps) of rate cuts in the remaining two policy meetings this year, although rexmarks from policymakers indicated that the decision will depend on the upcoming inflation and labour data.
Looking ahead, traders will closely monitor the US PCE inflation data later on Friday. The headline US PCE is expected to show an increase of 2.7% YoY in August, while the core PCE is projected to show a rise of 2.9% during the same period. Any signs of softer inflation could strengthen the case for Fed rate cuts and drag the DXY lower.
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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