The US dollar index (DXY), which measures the value of the US dollar (USD) against six major currencies, is falling after two days of gains and is at around 97.90 during Asian hours on Friday. Investors will be watching Michigan’s preliminary February consumer sentiment index, which will be released later in the North American session.
The dollar is weakening as the latest U.S. labor market data shows a cooling of the labor market, reinforcing the Fed’s dovish expectations. Markets are currently pricing in two interest rate cuts this year, starting in June and another potentially in September.
CME’s FedWatch tool suggests markets are pricing in a nearly 77.3% chance that the Federal Reserve (Fed) will keep interest rates steady at its March policy meeting, expecting the first rate cut in June.
Data from the U.S. Department of Labor showed that unemployment claims rose to 231,000 in the week ending Jan. 31, above estimates of 212,000. and previous 209 thousand Meanwhile, ADP reported that private sector employment increased by only 22,000 in January, well below expectations of 48,000. and previous 37 thousand (corrected from 41 thousand).
However, DXY remains near two-week highs, supported by a slowing pace of potential interest rate cuts by the Federal Reserve (Fed). Fed Governor Lisa Cook said she would not support another rate cut without clearer evidence that inflation is falling, emphasizing greater concern about halting disinflation than about labor market weakness.
Traders also weighed the ramifications of Kevin Warsh’s nomination to lead the Fed, citing his preference for a smaller balance sheet and a less aggressive approach to interest rate cuts. The nomination also eased concerns about the Fed’s independence.
US Dollar FAQs
The United States 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 circulates alongside local banknotes. As of 2022, it is the most popular currency in the world, accounting for over 88% of all global foreign exchange turnover, or an average of $6.6 trillion in transactions daily. After World War II, the US dollar 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 was abolished.
The single most essential factor influencing the value of the US dollar is the monetary policy set by the Federal Reserve (Fed). The Fed has two missions: achieving price stability (controlling inflation) and promoting full employment. The basic tool for achieving these two goals is the adjustment of interest rates. When prices rise too swift and inflation exceeds the Fed’s 2% target, the Fed will raise interest rates, which will improve the value of the USD. When inflation falls below 2% or the unemployment rate becomes too high, the Fed may lower interest rates, which will negatively impact the dollar.
In extreme situations, the Federal Reserve can also print more dollars and implement quantitative easing (QE). QE is the process by which the Fed significantly increases the flow of credit in a gridlocked financial system. This is an unusual policy measure used when credit runs out because banks will not lend to each other (for fear of default by the counterparty). This is a last resort when lowering interest rates alone does not bring the required result. This was the Fed’s weapon of choice in the fight against the credit crunch that occurred during the Great Financial Crisis in 2008. It involves the Fed printing more dollars and using them to buy U.S. government bonds, mostly from financial institutions. QE usually leads to a weakening of the US dollar.
Quantitative Tightening (QT) is the reverse process in which the Federal Reserve suspends bond purchases from financial institutions and does not reinvest the principal amount of maturing bonds in recent purchases. This is usually positive for the US dollar.
