Safe-haven demand keeps United States Dollar Index steady

Diplomatic efforts to resolve the Middle East conflict temper safe-haven demand, leaving the US Dollar Index little changed.
Strong US economic figures and elevated expectations of a Fed rate rise could underpin the US Dollar.
Roughly a 75% probability of a December rate rise is priced into markets, according to the CME FedWatch Tool.

Near 102.00, the US Dollar Index (DXY) is holding steady in Monday’s Asian session. The index, which tracks the US Dollar (USD) against six major currencies, recorded modest gains the previous day.

TMGM Analysis: Financial Market News, Economic Calendar & Market Insights

Diplomatic efforts to end the Middle East conflict are reducing demand for safe havens, keeping the Greenback largely unchanged. Concerns about renewed US military action against Iran nevertheless persist. For a third consecutive day, Qatari and Iranian officials held talks aimed at securing an agreement to end the war before the US midterm elections.

Growing expectations of a Federal Reserve rate rise could, however, help the US Dollar recover. Recent US macroeconomic releases have signalled a resilient economy and persistent inflation, strengthening those expectations. The CME FedWatch Tool shows traders assigning roughly a 75% probability to a December rate increase.

The US Nonfarm Payrolls (NFP) report and ISM manufacturing and services figures are among the key releases traders are awaiting. Several Federal Reserve officials are also due to speak during the week, with their comments expected to provide additional direction on the central bank’s monetary policy outlook.

September PCE: Stalled inflation progress reshapes US Dollar outlook

The latest US September PCE report “confirms that progress on inflation has stalled.” That is the assessment of Brown Brothers Harriman. In line with consensus, the bank says, “headline PCE rose 0.5% m/m vs. +0.3% in August to be up 3.6% y/y vs. 3.4% in August,” while “core PCE was up 0.3% m/m vs. 0.3% in August to be up 3.1% y/y vs. 3.0% in August.” Persistent headline and core inflation strengthen the bank’s view that stalled disinflation continues to support the Dollar, despite market attention turning to wage trends and wider growth expectations.

US Dollar: Key Questions

The US Dollar’s role in global markets

As the official currency of the United States of America, the US Dollar (USD) also circulates alongside local banknotes as the ‘de facto’ currency in a significant number of other countries. No other currency is traded more heavily worldwide. According to 2022 data, it represents over 88% of global foreign exchange turnover, equivalent to average daily transactions of $6.6 trillion. After the Second World War, the USD replaced the British Pound as the world’s reserve currency. Gold backed the US Dollar for most of its history, until the Bretton Woods Agreement in 1971 brought the Gold Standard to an end.

Federal Reserve policy and the US Dollar

Monetary policy is the single biggest influence on the US Dollar’s value. The Federal Reserve (Fed) sets that policy under its dual mandate of price stability, or inflation control, and full employment. Adjusting interest rates is its main means of pursuing both objectives. With inflation above the Fed’s 2% target and prices climbing too rapidly, the central bank will raise rates, supporting the USD. Conversely, inflation below 2% or an excessively high Unemployment Rate may prompt the Fed to cut interest rates, putting pressure on the Greenback.

Quantitative Easing: Implications for the US Dollar

When conditions become extreme, the Federal Reserve can print additional Dollars and introduce quantitative easing (QE). Through QE, the Fed sharply expands the flow of credit within a financial system that has become blocked. This unconventional policy addresses a credit shortage caused by banks refusing to lend to one another for fear of counterparty default. It serves as a last resort when interest rate cuts alone are unlikely to deliver the required outcome. During the Great Financial Crisis in 2008, QE was the Fed’s preferred response to the credit crunch. The process entails printing more Dollars to purchase US government bonds, mainly from financial institutions. The US Dollar typically weakens as a result of QE.

Quantitative Tightening: Implications for the US Dollar

In the reverse process, quantitative tightening (QT), the Federal Reserve ceases bond purchases from financial institutions. It also allows bonds in its portfolio to mature without reinvesting the principal in new purchases. This process generally supports the US Dollar.