United States Dollar Index weakens to near 101.00 despite mounting Middle East tensions
- US Dollar Index softens to around 101.15 in Wednesday’s Asian session.
- Market expectations point to unchanged Fed policy next week, with Fed funds futures pricing in nearly a 74.9% chance.
- Houthi rebels threatened to open a front in the widening Middle East conflict.
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 101.15 in the Asian trading hours on Wednesday. The DXY declines amid US Federal Reserve (Fed) rate uncertainty. Traders continue to weigh escalations in the US-Iran war, which could shape monetary policy trajectories.
Softer US inflation data might lower the possibility of a US rate hike later this year, weighing on the US Dollar against its rivals. Markets continue to anticipate no change to rates at the Fed's next meeting on July 29, with Fed funds futures pricing an implied 74.9% chance of a hold, compared to a 61.5% odds a month ago, according to the CME FedWatch tool.
On the other hand, escalating conflict between the US and Iran could boost the DXY as a safe-haven asset. The US military has launched an 11th consecutive night of strikes against Iran, with explosions reported in northwestern Iran’s Tabriz region.
Additionally, Yemen’s Houthis threaten to close Bab el-Mandeb, raising fears of wider conflict, further disrupting global oil supplies and international trade. Bab el-Mandeb is a vital shipping chokepoint, connecting the Red Sea to the Gulf of Arabia.
"A continuation of the Middle East conflict should support the dollar because of its safe-haven status and typically positive correlation with oil prices," said Commonwealth Bank of Australia currency strategist Samara Hammoud.
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.
