US Dollar Index declines to near 98.00 on Fed independence worries, rate cut bets
- US Dollar Index softens to around 98.15 in Friday’s Asian session.
- Concerns about the Fed's independence and US interest rate cut bets weigh on the DXY.
- Traders await the release of the US employment report for December next week for fresh impetus.
The US Dollar Index (DXY), an index of the value of the US Dollar (USD) measured against a basket of six world currencies, trades on a softer note near 98.15 during the Asian trading hours. Traders brace for US economic data this month to gauge the path of interest rates.
Concerns about the Federal Reserve's (Fed) independence under the US President Donald Trump administration could undermine the US Dollar against its rivals. Traders believe Trump will name a dovish successor to Fed chair Jerome Powell, whose term ends in May, after the US President repeatedly criticized Powell last year for not cutting rates more swiftly or deeply.
"We expect that concerns around central bank independence will extend into 2026, and see the upcoming change in Fed leadership as one of several reasons why risks around our Fed funds rate forecast skew dovish," said Goldman strategists.
Financial markets are pricing in two rate cuts in the year compared to one predicted by a divided Fed. According to the CME FedWatch tool, financial markets are pricing in nearly a 15.0% probability that the US central bank will cut interest rates at its next meeting in January.
The attention will shift to the key US economic data, including the US Nonfarm Payrolls (NFP) and Unemployment Rate data, which will be published next week. These reports could offer some hints about the health of the labour market and the US interest rate this year. If the US employment data show a stronger-than-expected outcome, this could help limit the DXY’s losses in the near term.
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.
