The US Dollar Index (DXY), an index of the value of the US dollar (USD) measured against a basket of six global currencies, is currently near 100.10 during Asian trading hours on Monday. DXY remains stable near a monthly high amid escalating tensions in the Middle East and rising expectations of a Federal Reserve (Fed) interest rate hike.
The Israel Defense Forces (IDF) said it struck military targets in western and central Iran hours after Iran fired a volley of rockets into northern Israel, the BBC reported on Monday. Iranian state television reported that sounds of explosions were heard in Isfahan, Tabriz and Tehran, but gave no details.
US President Donald Trump said on Sunday he would tell Israeli Prime Minister Benjamin Netanyahu not to strike back after Iran fired a volley of missiles at Israeli targets in retaliation for an attack on a “beirut suburb,” according to Axios. Rising tensions in the Middle East may raise flows to safe and sound havens, supporting the US dollar against rivals in the near future.
In May, the US economy recorded its third consecutive month of mighty job growth. According to the Bureau of Labor Statistics, the U.S. nonfarm payroll (NFP) employment rate increased by 172,000 in May. compared to an raise of 179 thousand (corrected from 115 thousand). This number turned out to be higher than market expectations of 85,000. Additionally, the unemployment rate in May remained unchanged at 4.3%, in line with market consensus.
According to CME’s FedWatch tool, markets are now pricing in a greater than 70% probability that the Fed will raise interest rates in December, a piercing raise from a 45% probability a week ago.
“The released U.S. wages report… paints a picture of a U.S. labor market that is strengthening despite the ongoing energy price shock,” said Jonas Goltermann, chief markets economist at Capital Economics.
“This combination makes Fed tightening later this year increasingly likely… we now expect the FOMC to deliver two 25 basis point rate increases later this year in response to the energy supply shock and a renewed acceleration in the U.S. labor market,” Goltermann added.
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 fresh purchases. This is usually positive for the US dollar.
