- DXY trades with negative bias for the second straight day, though the downside seems limited.
- The Fed’s hawkish shift remains supportive of elevated US bond yields and favors the USD bulls.
- Geopolitical risks and trade war fears might contribute to limiting losses for the safe-haven buck.
The US Dollar Index (DXY), which tracks the Greenback against a basket of currencies, drifts lower for the second straight day on Monday and retreats further from its highest level since November 2022 touched last week. The index retains its negative bias through the first half of the European session and currently hovers around the 108.70-108.65 area, down 0.25% for the day, though the fundamental backdrop warrants caution for bearish traders.
The US ISM Manufacturing PMI improved from 48.4 to 49.3 in December, pointing to signs of economic resilience and potential for growth amid the optimism over US President-elect Donald Trump’s expansionary policies. This, in turn, validates the Federal Reserve’s (Fed) hawkish shift in December, signaling that it would slow the pace of interest rate cuts in 2025, which remains supportive of elevated US Treasury bond yields. In fact, the yield on the benchmark 10-year US government bond reached its highest point since May 2 and favors the USD bulls.
Apart from this, persistent geopolitical risks stemming from the protracted Russia-Ukraine war and tensions in the Middle East, along with concerns about Trump’s tariff plans, support prospects for the emergence of dip-buying around the safe-haven buck. Hence, any subsequent USD fall could be seen as a buying opportunity and remain limited ahead of this week’s important US macro releases, including the Nonfarm Payrolls (NFP) on Friday. In the meantime, traders on Monday might take cues from the final US Services PMI and Factory Orders data.
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.
