Experts agree: Fed policy outlook and geopolitical tensions keep US Dollar bid
- The US Dollar Index rallies 0.6% in three days and hits fresh two-week highs above 102.00.
- Investors return to the US Dollar as markets brace for a hawkish hold by the Fed on Wednesday.
- Waning hopes of any immediate US-Iran peace deal have provided additional support to the safe-haven USD.
The US Dollar has been one of the strongest performers among major currencies in the last few sessions. The US Dollar Index (DXY), which measures the value of the US Dollar (USD) against a basket of six peers, has rallied more than 0.6% over the last three trading days to hit two-week highs above 102.00, with investors awaiting the outcome of the Federal Open Market Committee (FOMC) meeting, due next Wednesday.
Traders have turned long on the US Dollar this week, with markets bracing for a hawkish hold by the Federal Reserve (Fed) to confirm expectations of a quarter-point rate hike in December. Beyond that, the latest attempt to de-escalate tensions in the Middle East has ended like the previous ones, in nothing, while the ongoing skirmishes between regional powers and the attacks in the Strait of Hormuz provide additional support to the USD amid its safe-haven status.
Dollar support seen building ahead of key Fed decision
According to ING’s Chris Turner, with “energy prices firm and expectations growing that the US and Israel will launch another attack on Iran (...) we expect central banks to stay hawkish. This should keep the dollar supported on dips.”
In a similar vein, Analysts at HSBC "expect the USD to consolidate near its recent highs over the coming weeks, with risks tilted towards further gains rather than material weakness."
HSBC defends a more neutral USD outlook, with the bank's experts arguing that "US economic resilience, a hawkish Federal Reserve and potential challenges for other currencies should limit the USD’s downside, without necessarily providing the momentum for another leg higher."
TD Securities points in the same direction, highlighting persistent inflation risks and forecasting a cautious FOMC stance after Wednesday's meeting. "A hold in October will make a December hike all the more likely,” according to the TD Securities expert.
Eurozone credit tensions increase demand for the USD
Strategists at Brown Brothers Harriman point out that October's ECB survey “showed a further net tightening of credit standards and weaker loan demand in Q3,” a combination that “is a headwind to Eurozone economic activity and challenges the nearly 75bps of ECB hikes priced by markets over the next twelve months.”
In the US, “September durable goods orders and ADP weekly employment change will likely underscore the resilience of the economy,” says BBH, adding that “rising gasoline prices point to worsening near-term inflation expectations in October’s consumer confidence survey.” All in all, reinforcing the case for a firm Fed monetary policy stance.
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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