US Dollar Index (DXY) dives to fresh three-year lows below 98.00
- Risk aversion and hopes of Fed cuts are punishing the USD.
- Markets are growing sceptical about Trump's ability to cut significant trade deals.
- Recent Fed-ECB divergence is putting additional pressure on the US Dollar.
A mix of scepticism about US trade deals and hopes of further interest rate cuts by the Federal Reserve, following softer-than-expected consumer prices in May, has triggered a sharp US Dollar sell-off, sending the Dollar Index to fresh multi-year lows.
The USD Index (DXY), which measures the value of the US Dollar against the world’s most traded currencies, is testing levels right below 98.00 for the first time since April 2022, after having depreciated about 1.30% so far today.
Tariffs and Fed cut hopes are hurting the USD
Investors’ scepticism about the durability of a modest US-China trade deal, and Trump’s threats to implement unilateral tariffs on most trading partners from June 9, have undermined investors’ confidence in the US negotiators’ ability to reach significant deals. The risk-averse market is hammering the US Dollar against safe-haven currencies like the JPY and the CHF.
Apart from that, the USD is also plummeting against the Euro. The soft US inflation figures released on Wednesday have heightened expectations that the Fed will cut rates by 25 basis points in September.
This contrasts with the recently adopted hawkish stance of the European Central Bank and highlights a monetary divergence that has boosted the EUR/USD to fresh multi-year highs near 1.1600.
ECB President, Christine Lagarde, suggested after last week’s meeting that the bank might be close to the end of the easing cycle in a message that has been repeated by a number of European policymakers this week. In the absence of relevant Eurozone releases, these comments are providing significant support to the Euro.
Central banks FAQs
Central Banks have a key mandate which is making sure that there is price stability in a country or region. Economies are constantly facing inflation or deflation when prices for certain goods and services are fluctuating. Constant rising prices for the same goods means inflation, constant lowered prices for the same goods means deflation. It is the task of the central bank to keep the demand in line by tweaking its policy rate. For the biggest central banks like the US Federal Reserve (Fed), the European Central Bank (ECB) or the Bank of England (BoE), the mandate is to keep inflation close to 2%.
A central bank has one important tool at its disposal to get inflation higher or lower, and that is by tweaking its benchmark policy rate, commonly known as interest rate. On pre-communicated moments, the central bank will issue a statement with its policy rate and provide additional reasoning on why it is either remaining or changing (cutting or hiking) it. Local banks will adjust their savings and lending rates accordingly, which in turn will make it either harder or easier for people to earn on their savings or for companies to take out loans and make investments in their businesses. When the central bank hikes interest rates substantially, this is called monetary tightening. When it is cutting its benchmark rate, it is called monetary easing.
A central bank is often politically independent. Members of the central bank policy board are passing through a series of panels and hearings before being appointed to a policy board seat. Each member in that board often has a certain conviction on how the central bank should control inflation and the subsequent monetary policy. Members that want a very loose monetary policy, with low rates and cheap lending, to boost the economy substantially while being content to see inflation slightly above 2%, are called ‘doves’. Members that rather want to see higher rates to reward savings and want to keep a lit on inflation at all time are called ‘hawks’ and will not rest until inflation is at or just below 2%.
Normally, there is a chairman or president who leads each meeting, needs to create a consensus between the hawks or doves and has his or her final say when it would come down to a vote split to avoid a 50-50 tie on whether the current policy should be adjusted. The chairman will deliver speeches which often can be followed live, where the current monetary stance and outlook is being communicated. A central bank will try to push forward its monetary policy without triggering violent swings in rates, equities, or its currency. All members of the central bank will channel their stance toward the markets in advance of a policy meeting event. A few days before a policy meeting takes place until the new policy has been communicated, members are forbidden to talk publicly. This is called the blackout period.
Author
Guillermo Alcala
FXStreet
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.
