The pound sterling (GBP) opened at around 1.3240 against the US dollar (USD) at the start of the week, the lowest level in almost two weeks. GBP/USD is under selling pressure as fears of a potential United States (US) invasion of Iran weighed on demand for riskier assets.
At press time, S&P 500 futures were down 0.5%, reflecting the gloomy market sentiment. The U.S. Dollar Index (DXY), which tracks the value of the dollar against six major currencies, continued its mighty streak for a fifth trading day on Monday, rising to nearly 100.35.
Late Thursday, a Wall Street Journal (WSJ) report showed that the US Pentagon is considering sending 10,000 additional troops to Iran. In response, Iranian Brigadier General Ebrahim Zolfaqari issued a stern warning on Iranian state television, saying that “US troops will be good food for the sharks of the Persian Gulf.”
The fear of further deepening of conflicts in the Middle East creates the risk of persistently higher oil prices, which is an unfavorable scenario for the currencies of economies such as the United Kingdom (UK), which largely base their energy needs on oil imports.
On a macro note, the main drivers for GBP/USD will be the release of key US economic data this week, which includes various labor market-related indicators, in particular non-farm payrolls data and ISM Purchasing Managers’ Index (PMI) data, which will influence market expectations of the Federal Reserve’s (Fed) monetary policy outlook.
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 critical 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 rapid 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 the 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 novel purchases. This is usually positive for the US dollar.
