US Dollar Index (DXY) hits three-week highs at 99.40 buoyed by risk aversion
- The extends its recovery with fears of a wider Middle East conflict boosting demand for safe assets.
- Iranian authorities have threatened with "severe consequences to the US
- From a wider perspective, however, the US Dollar remains on the defensive after having depreciated 8.5% so far this year.
The Dollar has reclaimn¡med its traditional safe-haven status, with investors rushing away from risk on concerns about the possibility of a wider conflict in the Middle East after this weekend’s attack on Iran’s nuclear sites.
The US Dollar is the strongest of the G8 currencies on Monday. The US Dollar Index, which measures the value of the Greenback against the world’s most traded currencies, has jumped above last week’s highs and is trading right below June’s top, at 99.40.
The US launched an attack on some of the key Iranian nuclear plants last weekend, including the critical underground Fordow facility, which, according to President Trump, has devastated the country’s Nuclear program.
Iranian officials have vowed revenge that will have “severe consequences for the US. With the world holding its breath to avoid a wider regional war that will spill well beyond the Iranian borders, the risk-off sentiment is boosting the US Dollar to the detriment of riskier currencies.
The index, however, still remains 2.5% below mid-May highs and nearly 10% below January’s highs. The softer macroeconomic data and Trump’s erratic policies have seriously damaged the US economic outlook and have been undermining US dollar demand for the last few months.
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
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.
