United States Dollar Index gains ground above 99.50 as Middle East tensions, hot US PPI fuel demand
- US Dollar Index strengthens to around 99.80 in Friday’s Asian session.
- US forces downed Iranian drones going for strikes on Hormuz shipping.
- The annual US PPI inflation rate was the highest since November 2022; the monthly PPI gain matched the April increase.
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 99.80 during the Asian trading hours on Friday. The DXY gathers strength amid uncertainty in the Middle East and a hot US inflation report. The preliminary reading of the Michigan Consumer Sentiment Index for June will be released later on Friday.
Fox News reported on Friday that US forces intercepted and shot down two Iranian one-way attack drones near the Strait of Hormuz after Iran attempted to target commercial vessels transiting the waterway.
This development came after US President Donald Trump said that he cancelled new military strikes on Iran on Thursday as negotiators were close to reaching an agreement on the final elements of a deal. Escalating tensions in the Middle East could boost the US Dollar against its rivals in the near term.
The US Bureau of Labor Statistics revealed on Thursday that US producer prices increased more than expected in May, leading to the highest level since November 2022. The US Producer Price Index (PPI) climbed 6.5% YoY in May, versus 5.7% prior, hotter than the market expectation of 6.4%. On a monthly basis, the PPI rose by 1.1% in May, above the market consensus of 0.7%.
Meanwhile, the core PPI rose by 4.9% on a yearly basis, matching April's print but coming in well below the estimations of 5.4%. Still, the current state of inflation is likely to keep the Federal Reserve (Fed) on the sidelines for the foreseeable future.
Markets are now pricing in a 43% odds of a quarter-point rate hike in December, up from just about 14% a month ago, according to the CME FedWatch tool.
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
Lallalit Srijandorn
FXStreet
Lallalit Srijandorn is a Parisian at heart. She has lived in France since 2019 and now becomes a digital entrepreneur based in Paris and Bangkok.
