US Dollar Index falls to near 98.00 due to dovish Fed expectations, upcoming CPI eyed
- The US Dollar Index struggles amid signs of weakness in recent US economic data.
- CME FedWatch Tool suggests that markets are pricing in roughly an 89% probability of a Fed rate cut in September.
- Fed Governor Michelle Bowman remarked that three interest rate cuts are likely to be appropriate this year.
The US Dollar Index (DXY), which measures the value of the US Dollar (USD) against six major currencies, is retracing its recent gains and trading around 98.00 during the Asian hours on Monday. Traders will likely watch Tuesday’s US consumer inflation data, followed by the release of the preliminary UK Q2 GDP print and the US Producer Price Index (PPI) on Thursday.
The Greenback faces challenges as the soft US economic data prompted traders to price in the possibility of more interest rate cuts this year. The higher Initial Jobless Claims and lower July’s Nonfarm Payrolls in the United States (US) have boosted the expectations for a Fed rate cut next month, with another possible move in December. Markets are now pricing in approximately 89% odds of a Fed rate cut at the September meeting, up from 80% a week ago, according to the CME FedWatch tool.
Moreover, Fed Governor Michelle Bowman stated on Saturday that three interest rate cuts are likely to be appropriate this year. Bowman also said that the apparent weakening in the labor market outweighs the risks of higher inflation to come.
On Friday, St. Louis Fed President Alberto Musalem noted that US economic activity remains stable but warned of potential risks ahead, noting the Fed could fall short on both its inflation and employment goals, with particular downside risks to jobs. Musalem emphasized that the Fed is currently balancing risks on both sides of its mandate and stressed that data integrity is critically important to the economy, per Reuters.
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
Akhtar Faruqui
FXStreet
Akhtar Faruqui is a Forex Analyst based in New Delhi, India. With a keen eye for market trends and a passion for dissecting complex financial dynamics, he is dedicated to delivering accurate and insightful Forex news and analysis.
