The US Dollar Index (DXY), which measures the value of the US Dollar (USD) against six major currencies, is holding gains after two successive flat days and trading around 100.90 during the European hours on Tuesday. The Greenback received support from safe-haven demand amid renewed geopolitical tensions.
Strait of Hormuz tensions emerged after reports that Iran fired at least two missiles at commercial vessels transiting the strategic waterway late Monday. While two ships sustained significant damage, no casualties were reported. Separately, the UK Maritime Trade Operations (UKMTO) confirmed that a southbound tanker was struck on its port side by an unknown projectile, which ignited a fire on board.
However, the upside of the Greenback could be restrained as traders price out any Federal Reserve rate hikes this month and in September. This shift in sentiment followed a cooling employment report that revealed fewer jobs added across April, May, and June than Wall Street had anticipated.
Additionally, business activity in the US service sector cooled slightly; it remained firmly in expansionary territory, with the June ISM Services Purchasing Managers’ Index (PMI) easing to 54.0 from 54.5, as expected, in line with consensus estimates. Within the sub-components of the report, the Prices Index dipped from 71.3 to 67.7, while the Employment Index saw a notable improvement, climbing out of contractionary territory from 47.9 to 51.2.
The Greenback could find baseline support from hawkish remarks by Federal Reserve (Fed) Governor Christopher Waller and resilient domestic economic data.
Waller underscores forward guidance limits while reaffirming Fed’s inflation resolve
Fed’s Waller delivers a moderately more impactful speech than usual, with a 7.1/10 FXS Speechtracker score compared to the established baseline of 6.4/10, focused on the nuanced role of forward guidance. The emphasis that forward guidance can both accelerate policy transmission and become a hindrance when too rigid or used amid highly uncertain outcomes signals a preference for flexibility and data dependence rather than pre-commitment. Later remarks reaffirm the credibility of the 2% inflation pledge, reject using low rates to ease U.S. deficit financing, and highlight shifting risks as inflation “taking off” and a stabilized labor market alter the policy calculus, all of which lean modestly hawkish for the Dollar.
The FXS Fed Sentiment Index rises by 1.83 points to 125.72, reinforcing a clear hawkish stance well above the neutral 100 threshold. The combination of a stronger-than-baseline FXS Speechtracker score and an index level firmly in hawkish territory suggests markets will continue to price a vigilant Fed reaction function, supportive of the Dollar against the Euro and Yen.
US Dollar FAQs
The US 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 is found in circulation alongside local notes. It is the most heavily traded currency in the world, accounting for over 88% of all global foreign exchange turnover, or an average of $6.6 trillion in transactions per day, according to data from 2022.
Following the second world war, the USD 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 went away.
The most important single factor impacting on the value of the US Dollar is monetary policy, which is shaped by the Federal Reserve (Fed). The Fed has two mandates: to achieve price stability (control inflation) and foster full employment. Its primary tool to achieve these two goals is by adjusting interest rates.
When prices are rising too quickly and inflation is above the Fed’s 2% target, the Fed will raise rates, which helps the USD value. When inflation falls below 2% or the Unemployment Rate is too high, the Fed may lower interest rates, which weighs on the Greenback.
In extreme situations, the Federal Reserve can also print more Dollars and enact quantitative easing (QE). QE is the process by which the Fed substantially increases the flow of credit in a stuck financial system.
It is a non-standard policy measure used when credit has dried up because banks will not lend to each other (out of the fear of counterparty default). It is a last resort when simply lowering interest rates is unlikely to achieve the necessary result. It was the Fed’s weapon of choice to combat the credit crunch that occurred during the Great Financial Crisis in 2008. It involves the Fed printing more Dollars and using them to buy US government bonds predominantly from financial institutions. QE usually leads to a weaker US Dollar.
Quantitative tightening (QT) is the reverse process whereby the Federal Reserve stops buying bonds from financial institutions and does not reinvest the principal from the bonds it holds maturing in new purchases. It is usually positive for the US Dollar.
Source: Original Article
