US Dollar Index remains on the defensive below 97.00 as traders await the Fed rate decision
- US Dollar Index recovers some lost ground around 96.70 in Wednesday’s early Asian session, but upside seems limited.
- The prospect of a Fed rate reduction continues to undermine the US Dollar.
- The Fed rate decision will take center stage later on Wednesday.
The US Dollar Index (DXY), an index of the value of the US Dollar (USD) measured against a basket of six world currencies, remains on the defensive near 96.70 as investors firmed bets for a Federal Reserve (Fed) interest rate cut later on Wednesday.
Markets expect a 25 basis points (bps) rate cut at the Fed’s September meeting on Wednesday, after the US labor market has shown signs of a slowdown. According to the CME FedWatch tool, traders are now pricing in a near 100% probability of a quarter-point rate cut at the upcoming meeting. A small minority even sees a possibility of a jumbo rate cut.
Fed Chair Jerome Powell is scheduled to hold a press conference following the policy statement on Wednesday. Traders will keep an eye on the FOMC Press Conference and a Summary of Economic Projections (SEP), or ‘dot-plot,’ for some hints about the US interest rate path.
"The dollar is trading with a heavy tone across the board as investors brace for a dovish message in Wednesday’s voting record, ‘dot plot’ summary of economic projections, and press conference," said Karl Schamotta, chief market strategist at Corpay.
On the other hand, the risk-off mood or easing geopolitical tensions could boost the safe-haven flows, benefiting the DXY. US President Donald Trump said Zelenskyy will “have to get going and make a deal” to end the Russian invasion of Ukraine as he ramped up pressure on the EU and NATO countries to “stop buying oil from Russia.”
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
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.
