The US Dollar Index (DXY), which measures the value of the US Dollar (USD) against six major currencies, is extending gains for the third successive session and trading around 98.60 during the European hours on Friday. Traders will likely observe the University of Michigan Consumer Sentiment Index for December later in the day.
The upside of the US Dollar could be limited amid rising expectations of US Federal Reserve (Fed) rate cuts following the unexpectedly cooled US Consumer Price Index (CPI) inflation in November. The CME FedWatch tool shows a 73.3% probability of rates being held at the Fed’s January meeting, down from 75.6% a day earlier. Meanwhile, the likelihood of a 25-basis-point rate cut has risen to 26.6% from 24.4% a day ago.
The US Bureau of Labor Statistics (BLS) released on Thursday that the US Consumer Price Index (CPI) eased to 2.7% in November. This reading came in below the market consensus of 3.1%. Meanwhile, the US core CPI, which excludes volatile food and energy prices, rose by 2.6%, missing the expectation of 3.0%. This figure marks the slowest pace since 2021.
US President Donald Trump said on Thursday that the next chairman of the Federal Reserve (Fed) will be someone who believes in lower interest rates “by a lot.” Trump further noted that he will soon announce a successor to current Fed Chair Jerome Powell.
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.
