The US Dollar (USD) got struck by lightning on Wednesday during the last US Federal Reserve (Fed) rate decision for 2023. The Greenback did not get any relief on Thursday either after the European Central Bank (ECB) sent another batch of lightning strikes towards the Greenback. The fact that the Fed has openly committed to rate cuts in 2024, while the ECB kept its lips sealed and even said rate cuts were not even discussed, means a seismic shift in monetary policy between the two continents on either side of the Atlantic Ocean.
On the economic front, some relief could be in the pipeline for the much-battered US Dollar. Traders are looking towards the US Purchase Managers Index (PMI) numbers to get more insights. Should most or all PMI measures per sector recover back above 50, that would mean that on the economic front, the US would be outpacing Europe where all PMI’s have been in contraction for a few months already.
The US Dollar has had a melt down when looking at the past two performances, with at one point more than 2% losses in the US Dollar Index. The Fed has put its cards on the table with its Dot Plot projections, forced to show its hand as it would lose credibility if it didn’t. Look for European data to deteriorate further, should the ECB truly commit to keep rates unchanged throughout 2024, while the Fed is ready to provide oxygen to its economy, which investors will applaud in the long run.
The DXY US Dollar Index is facing a tough recovery with several resistances added in its downturn this week. First level to try and recover is 102.44, the low of November 29th. If US Dollar bulls are able to close and open above that level, and preferably even test the level for support, the next upside level to watch is 102.95 (ahead of 103.00) and 103.51 at the 200-day Simple Moving Average.
To the downside, the DXY is positioned near the next pivotal 101.70, the low of August 04 and 10. Once broken, look for 100.82 to try and catch the falling knife with the bottoms from February and April. Should that snap, nothing will stand in the way of DXY heading to the sub 100 region.
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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