The US Dollar Index (DXY), which measures the value of the US Dollar (USD) against six major currencies, remains low after three consecutive days of gains and is around 99.50 during Asian hours on Thursday.
The dollar fell as risk aversion eased following news that Israel and Lebanon agreed on Wednesday to renew a ceasefire. However, this would require a “complete cessation” of fire by Iran-backed Hezbollah. The agreement was announced in a joint statement after US-led talks in Washington.
Israel and Lebanon do not maintain formal diplomatic relations, although they have also agreed to establish a number of “pilot security zones” in which the Lebanese armed forces “will assume exclusive control of the territory to the exclusion of all non-state actors.”
But on Thursday, the Wall Street Journal reported that US President Trump told advisers he would consider ending the ceasefire with Iran if Tehran killed US troops. Trump insisted the weeklong pause on airstrikes would remain intact despite a steady stream of violent skirmishes. Moreover, Trump said in an interview with the New York Post that a lockdown lasting through Labor Day is unlikely but possible, effectively extending the market’s timeline for Hormuz’s reopening.
The US dollar may recover amid rising expectations that the US Federal Reserve (Fed) will raise interest rates this year. Better-than-expected U.S. employment data, including May ADP private pay data and JOLTS job vacancies, suggest the U.S. labor market is resilient. These reports could prompt traders to raise bets that the Fed will keep interest rates higher for longer.
Expectations have changed significantly as the ongoing war in Iran continues to impact energy markets, driving up prices and increasing inflation. According to the CME FedWatch Tool, markets are currently pricing in a nearly 42% chance of a Fed rate hike in December.
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 speedy 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 modern purchases. This is usually positive for the US dollar.
