The US Dollar Index (DXY), which tracks the dollar against a basket of currencies, is starting the recent week on a positive note, although it lacks follow-through and remains below Friday’s high. The index is currently trading around 99.65, up 0.15% on the day.
Global risk sentiment remains uncertain amid further escalation of tensions in the Middle East, which in turn is seen as a key factor in further strengthening the status of the US dollar (USD) as the global reserve currency. The latest developments indicate that US President Donald Trump has given Iran a 48-hour deadline to reopen the Strait of Hormuz and threatened that if demand is not met, Iran will attack Iran’s energy infrastructure.
Iran responded by threatening to escalate attacks on energy infrastructure and target critical water desalination plants in the Middle East if Trump keeps his promise to “destroy” the country’s power plants. This continues to support elevated oil prices, stoking inflation fears and forcing investors to withdraw expectations for US Federal Reserve (Fed) interest rate cuts in 2026. This further supports the dollar.
Meanwhile, the US central bank last week forecast one interest rate cut this year. Meanwhile, major central banks around the world have signaled the potential for interest rate increases to quell renewed inflationary pressures. This, in turn, deters USD bulls from placing aggressive bets and acts as a headwind for DXY. However, the mixed fundamental backdrop requires caution before adopting a robust near-term direction.
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 vital 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 brisk 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 recent purchases. This is usually positive for the US dollar.
