US Dollar Index rises to near 100.00 due to cautious Fed policy outlook
- US Dollar Index receives support from fading likelihood of further Fed rate cuts.
- The CME FedWatch Tool suggests pricing in a 65% probability of a Fed rate cut in December.
- Market sentiment remain cautious amid the ongoing US government shutdown.
The US Dollar Index (DXY), which measures the value of the US Dollar (USD) against six major currencies, is extending its winning streak for the fifth consecutive session and trading around 99.90 during the Asian hours on Tuesday. The Greenback receives support from the cautious sentiment surrounding the US Federal Reserve (Fed) policy stance for December.
Fed funds futures traders are now pricing in a 65% chance of a cut in December, down from 94% a week ago, according to the CME FedWatch Tool. The probability of a Fed rate cut in December decreased after cautious remarks from the Fed Chair Jerome Powell last week during the post-meeting press conference. Powell noted that another rate cut in December is far from certain and also cautioned that policymakers may need to take a wait-and-see approach until official data reporting resumes.
However, the US Dollar may face challenges as market caution prevails amid the ongoing government shutdown, which could fuel economic concerns in the United States (US). The US government impasse has now entered its sixth week with no easy endgame in sight amid a deadlock in Congress on the Republican-backed funding bill. Meanwhile, federal workers across the country are going unpaid, adding to the uncertainty surrounding the economic picture.
Institute for Supply Management's (ISM) Manufacturing Purchasing Managers' Index (PMI) dropped to 48.7 from 49.1 in September, showing a deeper-than-expected contraction and cooling price pressures. This reading came in weaker than the market expectation of 49.5. Factory Orders and JOLTS Job Openings data for September will be eyed later in the day.
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.