US Dollar Index (DXY) recovery loses steam above 98.00 despite the risk-off mood
- The languishes near multi-week lows despite the higher demand for safe havens.
- Fears of escalating tensions in the Middle East have crushed investors' appetite for risk.
- Market movements remain subdued ahead of Wednesday's Fed decision.
Fears of an escalating war between Israel and Iran are boosting demand for safe havens on Tuesday, but the US Dollar is failing to draw any significant support from the context. The US Dollar Index is struggling to extend gains past the 98.00 level and remains dangerously close to the multi-year lows, at 97.50 hit last week.
The Dollar bounced up on Monday and extended gains on early Tuesday trading, with investors rushing for safety as US President Trump called the National Security Council and left the G7 meeting one day ahead of schedule.
Trump denied that his hasty departure was related to a cease-fire in the Middle East, shortly afterwards, and affirmed that it was due to a “much bigger” reason. The comments have not helped to restore market sentiment.
Weak US data is weighing on the US Dollar
The Dollar is suffering as recent US data reveals the negative impact of Trump’s erratic trade policy. Later today, US Retail Sales are expected to have contracted at a 0.7% pace in May, following a 0.1% increase in April.
These figures come after a string of downbeat data, the latest being a larger-than-expected deterioration in the New York manufacturing activity, seen on Monday, which has been feeding hopes of further Fed easing after the summer.
Market volatility, however, remains subdued with all eyes on the outcome of the Federal Reserve’s monetary policy meeting, due on Wednesday. The summary of economic projections and the dot plot will help to define the bank’s stance and will set the USDollar’s near-term direction.
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.
