The US Dollar Index (DXY) is currently trading at 104.50, maintaining a neutral stance. Strong The overall Q2 growth backed by the Federal Reserve’s (Fed) cautious stance has offered mild gains to the US Dollar at the end of the week.
Despite some signs of softness, the US economy continues to exhibit robust growth in Q2 overall, directly influencing the cautious stance adopted by Fed officials. This reluctance to implement rate cuts seems to be keeping the Greenback afloat and limiting the downside.
The daily chart indicators are exhibiting signals of uncertainty. Despite the Relative Strength Index (RSI) staying flat in negative territory, it does not fully endorse the presence of a robust selling momentum. Similarly, the Moving Average Convergence Divergence (MACD) is flat with red bars, indicating a potential pause in the aggressive bearish trend.
On the flip side, the Simple Moving Averages (SMAs) paint a contrasting picture. The DXY Index, after having sustained a fall and subsequently rebounded at the 100-day SMA, remains below the 20-day SMA. This suggests that the bears had been temporarily holding ground. However, remaining above the 100 and 200-day SMAs indicates that the bulls are not entirely out of the picture.
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.