The US Dollar Index (DXY) trims its gains on Monday after opening the week on a firmer note, as traders await greater clarity on the Federal Reserve’s (Fed) interest rate path before placing fresh directional bets. At the time of writing, the index, which tracks the US Dollar against a basket of six major currencies, is trading around 100.92 after easing from an intraday high of 101.14.
The Fed is unlikely to raise interest rates anytime soon after Thursday’s weaker-than-expected US Nonfarm Payrolls (NFP) report. At the same time, Oil prices have fully unwound their US-Iran war-driven rally as shipping through the Strait of Hormuz continues to improve following last month’s interim peace agreement between the United States and Iran.
Lower Oil prices have eased inflation risks, suggesting the Fed may not need to tighten monetary policy as aggressively as markets had previously feared.
Even so, with inflation still running above the Fed’s 2% target, policymakers remain committed to bringing inflation back to target, suggesting monetary policy is likely to remain restrictive for the time being.
According to the CME FedWatch Tool, traders are pricing in a 77% probability that the Fed will keep interest rates unchanged at this month’s meeting, while the probability of a rate hike at the September meeting has fallen to 56% from 63% before the US jobs report was released.
Meanwhile, the United States and Iran have yet to reach a final agreement. Key sticking points include the future management of the Strait of Hormuz, the release of frozen Iranian assets, sanctions relief, and Tehran’s commitments regarding its nuclear program.
With geopolitical risks lingering and traders still pricing in at least one Fed rate hike this year, further downside in the US Dollar is likely to remain limited.
On the data front, the ISM Services Purchasing Managers Index (PMI) came in at 54 in June, in line with market expectations. Although the reading eased from 54.5 in May, it marked the 23rd consecutive month of expansion.
The US economic calendar is relatively light this week, with the ADP Employment Change report due on Tuesday and weekly Initial Jobless Claims on Thursday. Investors will also closely watch the Federal Open Market Committee (FOMC) meeting minutes on Wednesday for fresh clues on the Fed’s monetary policy outlook.
Fed FAQs
Monetary policy in the US is shaped by the Federal Reserve (Fed). The Fed has two mandates: to achieve price stability and foster full employment. Its primary tool to achieve these goals is by adjusting interest rates.
When prices are rising too quickly and inflation is above the Fed’s 2% target, it raises interest rates, increasing borrowing costs throughout the economy. This results in a stronger US Dollar (USD) as it makes the US a more attractive place for international investors to park their money.
When inflation falls below 2% or the Unemployment Rate is too high, the Fed may lower interest rates to encourage borrowing, which weighs on the Greenback.
The Federal Reserve (Fed) holds eight policy meetings a year, where the Federal Open Market Committee (FOMC) assesses economic conditions and makes monetary policy decisions.
The FOMC is attended by twelve Fed officials – the seven members of the Board of Governors, the president of the Federal Reserve Bank of New York, and four of the remaining eleven regional Reserve Bank presidents, who serve one-year terms on a rotating basis.
In extreme situations, the Federal Reserve may resort to a policy named 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 during crises or when inflation is extremely low. It was the Fed’s weapon of choice during the Great Financial Crisis in 2008. It involves the Fed printing more Dollars and using them to buy high grade bonds from financial institutions. QE usually weakens the US Dollar.
Quantitative tightening (QT) is the reverse process of QE, whereby the Federal Reserve stops buying bonds from financial institutions and does not reinvest the principal from the bonds it holds maturing, to purchase new bonds. It is usually positive for the value of the US Dollar.
Source: Original Article
