United States Dollar Index struggles due to weak tech earnings
- The US Dollar Index faces headwinds after disappointing megacap earnings sparked concerns about the sustainability of AI trade.
- Escalating Middle East conflict and potential post-midterm US-Israeli strikes on Iran boosted alternative safe-haven currencies.
- Fed Chair Kevin Warsh signaled little urgency to tighten policy further, despite high market-priced odds of another rate hike.
The US Dollar Index (DXY), which measures the value of the US Dollar (USD) against six major currencies, is remaining subdued for the fourth successive day and trading near 101.60 during Asian hours on Friday.
The Greenback struggled under pressure from mounting doubts regarding the sustainability of the AI trade. Investor confidence weakened after quarterly earnings reports from several megacap technology companies failed to meet expectations.
Meanwhile, escalating geopolitical conflict in the Middle East has driven broader market risk aversion. Reports indicating that the US and Israel are preparing additional military strikes against Iran following the upcoming midterm elections have intensified safe-haven demand, bolstering both the Japanese Yen and Swiss Franc against the Greenback.
Meanwhile, Federal Reserve (Fed) officials have indicated little urgency to accelerate policy tightening. Fed Chair Kevin Warsh recently expressed optimism regarding the underlying strength of the US economy but refrained from signaling whether additional interest rate hikes would be required. Despite this measured guidance, market participants utilizing the CME FedWatch Tool currently price in a 92.8% probability of a rate pause at the upcoming October 27–28 policy meeting.
Defensive FX seen outperforming as Dollar support holds at the short end
Analysts at ING argue that the current backdrop “probably favours a little more outperformance of the defensive currencies over commodity currencies,” reflecting a shift in market preference away from higher-beta FX. However, they caution that “until the rock-solid short-end of the US yield curve starts to buckle, it is hard to make the case that the Dollar needs to fall across the board,” suggesting that firm front-end US yields remain a key anchor for broad Dollar support even as relative performance within G10 FX begins to tilt toward more defensive names.
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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