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United States Dollar Index declines as Iran, Israel agree to halt strikes

  • US Dollar Index falls as Donald Trump's appeal led Iran and Israel to halt attacks, boosting peace hopes.
  • Netanyahu declared the war with Iran and Hezbollah "has not yet ended," keeping long-term stability elusive.
  • CME FedWatch tool indicates traders price in December 25-basis point rate hike with a probability of 42%.

The US Dollar Index (DXY), which measures the value of the US Dollar (USD) against six major currencies, is remaining subdued for the second successive day and trading around 100.00 during the Asian hours on Tuesday.

However, the Greenback loses ground after Iran and Israel agreed to halt mutual attacks. The de-escalation came after an appeal from US President Donald Trump, boosting hopes that peace negotiations could move forward.

However, the US Dollar may regain ground amid uncertainty surrounding the Middle East ceasefire. Israeli Prime Minister Benjamin Netanyahu stated the war against Iran and its Lebanon-based proxy, Hezbollah, "has not yet ended," though he insisted both entities are weaker than ever. Netanyahu’s remarks followed a statement from Iran’s military confirming it had ceased strikes against Israel. Nevertheless, Iran’s central military command issued a stern warning, declaring that if Israel continues its attacks, including those in southern Lebanon, "much harsher and more crushing actions than before will be on the way."

The ongoing geopolitical friction, combined with strong US jobs data, has fueled inflation fears and heightened expectations of Federal Reserve rate hikes. According to the CME FedWatch tool, traders have raised the probability of a December quarter-point rate hike to 42%, up from 14% a month ago. The market is now bracing for Wednesday's US Consumer Price Index (CPI) and Thursday's Producer Price Index (PPI) data to gauge the Fed's next move.

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.

Author

Akhtar Faruqui

Akhtar Faruqui is a Forex Analyst based in New Delhi, India. With a keen eye for market trends and a passion for dissecting complex financial dynamics, he is dedicated to delivering accurate and insightful Forex news and analysis.

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