US Dollar Index gathers strength to near 99.00 on Middle East tensions, US CPI data looms

US Dollar Index strengthens to around 98.90 in Tuesday’s early European session.
Geopolitical tensions in the Middle East boost the DXY.
Traders will take more cues from the US February CPI inflation data, which is due on Wednesday.

Lallalit Srijandorn FXStreet

The US Dollar Index (DXY), an index of the value of the US Dollar (USD) measured against a basket of six world currencies, currently trades near 98.90 during the early European trading hours on Tuesday. The DXY edges higher amid uncertainty and persistent geopolitical risks in the Middle East.

Iran’s Islamic Revolutionary Guard Corps (IRGC) said that Tehran will determine when the war ends, not the United States (US). The IRGC warned that if US and Israeli attacks continue, Iran could block regional oil exports. Meanwhile, US President Donald Trump stated that if Iran does anything that stops the flow of oil through the Strait of Hormuz, it will be hit by the US. Uncertainty and fears of a prolonged war in the Middle East could drive traders toward safe-haven currency such as the US Dollar in the near term.

The war in the Middle East stoked fears of inflation rising in the US, which increases the likelihood of the US Federal Reserve (Fed) keeping interest rates higher for longer. Markets currently see nearly a 95% odds that US rates will remain unchanged at the March meeting, according to the CME FedWatch tool.

On the other hand, the downbeat US February employment report put the Federal Reserve (Fed) in a tough spot. The February jobs report showed a decline of 92,000 payrolls, while the Unemployment Rate rose to 4.4% in February from 4.3% in January.

The US Consumer Price Index (CPI) inflation data for February will take center stage later on Wednesday. The headline CPI is estimated to show an increase of 2.4% YoY in February, while the core CPI is expected to show a rise of 2.5% during the same period. If the report shows hotter-than-expected outcomes, this could underpin the Greenback in the near term.

US Dollar FAQs

What is the US Dollar?

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.

How do the decisions of the Federal Reserve impact the US Dollar?

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.

What is Quantitative Easing and how does it influence the US Dollar?

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.

What is Quantitative Tightening and how does it influence the 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.

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