The US Dollar (USD) trades back to where it was ahead of the US Federal Reserve (Fed) meeting during the European trading session on Thursday. Traders quickly pared back initial losses on Wednesday after Fed Chairman Jerome Powell said that a 50-basis-point (bps) rate cut would not be the new normal, although the Greenback is retreating further this Thursday. Going forward, it looks like economic data ahead of each rate decision will determine the size of the cut, if any, an assumption that was perceived as rather hawkish by markets.
On the economic data front, traders can get their hands dirty already with the weekly Jobless Claims, particularly because Powell reiterated that the labor market is important for the Fed’s dual mandate. The Philadelphia Fed Manufacturing Index will also be published, giving markets some more insights on how the manufacturing side of the economy is holding up.
The US Dollar Index (DXY) is back in its range after a very brief field trip lower, outside of that bandwidth that is determining the DXY moves for the past few weeks. With this Fed rate cut and projections for this year, a gradual further easing of the Greenback should play out. Expect pressure to build up again on the lower end of the bandwidth, which could be snapped if economic data deteriorates and leads the Fed towards another 50-basis-point rate cut in November.
The upper level of the recent range remains 101.90. Further up, the index could go to 103.18, with the 55-day Simple Moving Average (SMA) at 102.74 on the way. The next tranche up is very misty, with the 200-day SMA and the 100-day SMA at 103.79, just ahead of the big 104.00 round level.
On the downside, 100.62 (the low from December 28, 2023) has been broken overnight, though was unable to get a daily close below it. Should it happen, the low from July 14, 2023, at 99.58, will be the next level to look out for. If that level gives way, early levels from 2023 are coming in near 97.73.
US Dollar Index: Daily Chart
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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