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 98.65 during the Asian trading hours on Wednesday. The DXY holds steady as traders await a closely watched US Federal Reserve (Fed) interest rate decision later on Wednesday.
The Fed is expected to hold the federal funds rate steady between 3.50% and 3.75%, where it has sat since January. This policy meeting is likely Chair Jerome Powell’s final session before a Fed Chair transition to nominee Kevin Warsh.
Traders will closely monitor Jerome Powell’s press conference after the rate decision for hints on how the Fed may react to the risks ahead. If the US central bank maintains a hawkish tone regarding persistent inflation, this could boost the US Dollar against its rivals in the near term.
“The question is what Powell is going to do, because he still holds the governor seat until 2028, so whether he chooses to resign after the expiry of the Chair term or if he stays on as a governor and as sort of a shadow Chair,” said Carol Kong, a currency strategist at Commonwealth Bank of Australia.
On Thursday, the preliminary reading of the US Gross Domestic Product (GDP) for the first quarter (Q1) and Personal Consumption Expenditures (PCE) Price Index inflation report will take center stage. If the reports show worse-than-expected outcomes, this 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.