United States Dollar Index weakens after Israel-Lebanon ceasefire deal
- US Dollar Index falls as easing risk aversion followed news that Israel and Lebanon agreed to renew their ceasefire on Wednesday.
- Geopolitical optimism was held in check after President Trump threatened to cancel the ceasefire if Tehran kills US troops.
- The Greenback may rally as strong May jobs data fuels expectations that the Federal Reserve will raise interest rates.
The US Dollar Index (DXY), which measures the value of the US Dollar (USD) against six major currencies, is remaining subdued after three successive days of gains and trading around 99.50 during the Asian hours on Thursday.
The Greenback lost ground on easing risk aversion following the news that Israel and Lebanon on Wednesday agreed to renew a ceasefire. However, it would require a "complete cessation" of fire by Iran-backed Hezbollah. The agreement was announced in a joint statement after US-led talks in Washington.
Israel and Lebanon do not have formal diplomatic relations, though also agreed to establish a number of “pilot security zones" in which the Lebanese armed forces "will take exclusive control of the territory to the exclusion of all non-state actors."
However, the Wall Street Journal reported on Thursday that the US President Trump has told aides that he would consider ending the ceasefire with Iran if Tehran kills US troops. Trump insisted that the week-long pause in airstrikes remains intact despite a steady stream of violent skirmishes. Moreover, Trump said in a New York Post interview that the blockade lasting until Labor Day is unlikely but possible, effectively extending the market's timeline for a Hormuz reopening.
The US Dollar may regain its ground amid rising expectations that the US Federal Reserve (Fed) will raise interest rates this year. Stronger-than-expected US jobs data, including the May ADP private payrolls and JOLTS job openings, suggested a resilient US labor market. These reports might prompt traders to raise their bets that the Fed will keep interest rates higher for longer.
Expectations have shifted significantly as the ongoing war in Iran continues to impact energy markets, pushing prices higher and driving inflation upward. Markets are now pricing in nearly a 42% chance of a Fed rate hike in December, 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
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.
