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 99.60 during the Asian trading hours on Wednesday. The DXY holds steady as traders wait on the sidelines ahead of the US Federal Reserve (Fed) interest rate decision later on Wednesday.
Intensifying conflict in the Middle East could boost the safe-haven demand, which supports the US Dollar against its rivals. The BBC reported on Tuesday that Iranian security chief Ali Larijani was killed in Israeli air strikes. Iranian army chief Amir Hatami vowed to launch a “decisive and regrettable” retaliation for the killing of security chief Ali Larijani in an Israeli air strike.
“Geopolitical tensions in the Middle East have once again reinforced the USD’s role as a primary safe-haven currency,” HSBC forex analysts wrote in a Thursday note.
The Federal Open Market Committee (FOMC) is expected to hold interest rates steady at 3.50%–3.75% at its March meeting on Wednesday. The ongoing war in Iran and oil price spikes have complicated the inflation outlook, making a rate cut highly unlikely at this time. Traders dialed back Fed easing expectations, with markets now assigning about 25 basis points (bps) of cuts this year, according to a Reuters poll.
Traders will closely monitor Fed Chair Jerome Powell’s remarks after the rate decision. Fed Chair Jerome Powell will hold one of his final press conferences before his term ends in May. Any hawkish remarks from Fed officials could lift the USD, while dovish comments from policymakers could drag the DXY lower.
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.