The US Dollar (USD) is opening the week a bit on the backfoot. Some selling pressure appeared in Asia on early Monday morning, ahead of a packed week with a lot of data points. The busy week in the macroeconomic calendar comes along with no speeches from US Federal Reserve (Fed) officials as they are in their blackout period ahead of the January 31 rate decision.
On the economic front, the main elements will come on Thursday and Friday, with the US Gross Domestic Product (GDP) numbers and the Personal Consumption Expenditures (PCE) Price Index, the Fed’s preferred inflation measure, respectively.. The European Central Bank (ECB) will also decide on monetary policy on Thursday. Until then, a very quiet start of the week is ahead on Monday, with no big economic data points scheduled.
The US Dollar Index (DXY) is facing substantial selling pressure. A daily chart shows a third consecutive day with lower highs and lower lows. This points to increasing selling pressure, while the DXY is failing to hold ground above the very important technical levels in the form of the 200-day Simple Moving Average (SMA) at 103.47 and the 55-day SMA at 103.28.
There are some economic data points that could still build a case for the DXY to get through those two moving averages again and run away. Look for 104.44 as the first resistance level on the upside, in the form of the 100-day SMA. If that gets scattered as well, nothing will hold the DXY from heading to either 105.88 or 107.20, the high of September.
A bull trap looks to be underway, where US Dollar bulls were caught buying into the Greenback when it broke above both the 55-day and the 200-day SMA in last week's trading. Price action could decline substantially and force US Dollar bulls to sell their positions at a loss. This would see the DXY first drop to 102.60, at the ascending trend line from September. Once below it, the downturn is open towards 102.00.
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.