The US Dollar Index (DXY), an index of the value of the US Dollar (USD) measured against a basket of six world currencies, currently trades near 101.30 during the early European trading hours on Tuesday. The DXY gathers strength and is heading for its biggest monthly gain in nearly a year on optimism over US economic growth and the prospect of Federal Reserve (Fed) interest rate hikes.
The Fed held its benchmark interest rate steady in a target range of 3.50% to 3.75% at its June policy meeting. The central bank’s update also removed a statement hinting that it was leaning towards lowering interest rates in the future.
A more hawkish turn at the Fed’s June meeting under new Fed Chair Kevin Warsh has led traders to increase bets on rate hikes this year, boosting the US Dollar across the board. Fed funds futures have priced in nearly a 63% chance of a rate hike by September, according to the CME FedWatch tool.
The US jobs report for June will take center stage later on Thursday. Three consecutive months of stronger-than-expected Nonfarm Payrolls (NFP) gains have supported the Fed’s hawkish shift.
Markets expect an increase of 110,000 jobs in June, and the Unemployment Rate is projected to hold steady at 4.3% during the same period. A turn in the labor market, however, could prompt a more dovish rethink of the monetary path, which would drag the DXY lower.
“The labor market appears to have accelerated,” said Marc Chandler, chief market strategist at Bannockburn Global Forex. “The concerns that the doves had pointed to about labor markets slowing down seem to have passed.”
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.
