The US Dollar Index (DXY), an index of the value of the US Dollar (USD) measured against a basket of six world currencies, trades on a softer note near 99.30 during the early European session on Friday. Traders brace for comments from Federal Reserve (Fed) policymakers later on Friday. Also, the preliminary reading of the U-Mich Consumer Sentiment report will be published.
The US government shutdown entered its tenth day on Friday as the Senate rejected funding bills from lawmakers that had the potential to bring the shutdown to an end. Concerns over the impact on the US economy could undermine the US Dollar against its rivals in the near term.
Minutes from the Fed’s September meeting released on Wednesday showed that a majority of policymakers supported the September rate cut and signaled further reduction later this year. However, some members favored a more cautious approach, citing concerns about inflation.
Markets are now pricing in nearly a 95% odds that the Fed cuts rates by 25 bps at its October meeting, while the odds of an additional reduction in December have dropped to 80%, from 90%, in the past week, according to the CME FedWatch Tool.
New York Fed President John Williams said on Thursday that he would be comfortable with cutting interest rates again. Meanwhile, Fed Governor Michael Barr said that the current outlook poses challenges for judging the stance of monetary policy and deciding the right path forward. Barr also noted that the Fed’s rate cut in September was appropriate.
Traders will take more cues from the speeches from the Fed’s Austan Goolsbee and Alberto Musalem later on Friday. Any hawkish remarks from Fed officials could lift the DXY in the near term.
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.