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United States Dollar Index extends losses as US and Iran attempt to resume talks

  • The US Dollar Index retreats further, nearing three-week lows at 100.56.
  • Rumours that US and Iran are working to resume peace talks have triggered a mild appetite for risk.
  • The Yen rallied after the Japanese government unveiled a plan to encourage pension funds to boost investment in domestic funds.

The US Dollar Index (DXY) is trading lower for the third consecutive day on Friday. A tense calm in Iran and news that mediating countries are working to bring Washington and Tehran back to the negotiating table are allowing a mild appetite for risk and weighing on the safe-haven US Dollar (USD).

The Dollar Index, which measures the value of the Greenback against a basket of six peers, is trading at 100.75 at the time of writing after bouncing from levels a few pips shy of the last three weeks' low of 100.56. 

US and Iranian forces have paused the tit-for-tat strikes launched over the previous two days while Qatar and Pakistan work to resume the peace process. A US official cited by CNN affirmed earlier on Friday that the US has been striking and then pausing deliberately to avoid escalation and let diplomacy work.

The rebound in oil prices benefits the USD

Traffic through the key Strait of Hormuz, however, has plunged, pushing oil prices nearly 10% higher from last week’s lows. This is hurting currencies like the Euro and the Japanese Yen amid the exposure of their respective economies to higher energy prices, and is keeping the Dollar from falling further.

In Japan, the Finance Minister, Satsuki Katayama, unveiled a plan to encourage pension funds to ramp up investment in domestic assets, in an attempt to repatriate billions of Dollars allocated in foreign markets. The Yen appreciated after the announcement, adding pressure on the Greenback.

Earlier this week, the minutes of the Federal Reserve’s June monetary policy meeting failed to support the US Dollar. The central bank showed a firm commitment to bring inflation to target, but committee members diverged over interest rates, casting a shadow on the timing for the next rate hike.

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

Guillermo Alcala

Graduated in Communication Sciences at the Universidad del Pais Vasco and Universiteit van Amsterdam, Guillermo has been working as financial news editor and copywriter in diverse Forex-related firms, like FXStreet and Kantox.

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