United States Dollar Index declines despite rising safe-haven demand, Fed rate hike odds
- US Dollar Index may regain ground as escalating Middle East tensions drive safe-haven demand.
- CENTCOM announced precision strikes on Iranian targets, noting over 50,000 US service members are deployed across the Middle East.
- The CME FedWatch Tool shows a 51% chance of a September Fed rate hike versus a 23% hold probability.
The US Dollar Index (DXY), which measures the value of the US Dollar (USD) against six major currencies, is losing ground after two days of gains and is trading around 101.20 during the Asian session on Tuesday.
However, the downside of the Greenback could be limited amid rising safe-haven demand due to escalating Middle East tensions. US Central Command (CENTCOM) announced new precision strikes on Iranian military targets, noting that over 50,000 US service members are currently deployed across the Middle East. Meanwhile, Iran’s IRGC stated that two "offending supertankers" were disabled in the Strait of Hormuz after ignoring warnings and using a mined route. Iran warned that cooperating with the US would delay the waterway's reopening and trigger a global energy crisis.
Hormuz tensions drive oil prices higher, stoking fears that energy-driven inflation will force the Federal Reserve (Fed) to keep interest rates elevated. Market expectations have shifted rapidly in response, with the CME FedWatch Tool now showing a 51% probability of a Fed rate hike in September, compared to just a 23% chance that rates will stay on hold.
Traders await Tuesday’s US June Consumer Price Index (CPI) report, where analysts anticipate a divergence between a 0.1% month-on-month decline in headline inflation and a sticky 0.3% increase in the core reading.
Also, Federal Reserve Chair Kevin Warsh will deliver highly anticipated congressional testimony, a session that traders will dissect word by word for hints on whether the central bank will validate the market's growing hawkishness.
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
FXStreet
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.
