The US Dollar Index (DXY), which gauges the value of the US Dollar against a basket of six major currencies, has shown a slight decline after experiencing modest gains in the previous trading session, hovering around the 98.50 mark during the Asian trading hours on Wednesday. Market participants are closely monitoring upcoming US economic indicators that could influence future Federal Reserve (Fed) policies.
Later today, traders will be particularly focused on the US ADP Employment Change and the ISM Services Purchasing Managers’ Index (PMI) for December. Attention will also shift to the highly anticipated US Nonfarm Payrolls (NFP) report set for release on Friday, which is forecasted to reveal a job gain of 55,000 for December, a decrease from November’s figure of 64,000.
The safe-haven US Dollar is retreating as traders largely appear unperturbed by escalating geopolitical tensions worldwide, including American intervention in Venezuela and the capture of President Nicolas Maduro. This environment presents challenges for the US Dollar as divisions within the Fed deepen. Moreover, US President Donald Trump’s forthcoming appointment of the next Fed Chair adds uncertainty to the monetary policy outlook.
The CME Group’s FedWatch tool indicates that futures markets are pricing in approximately 82.8% probability that the Fed will maintain interest rates at their current level during its meeting scheduled for January 27-28. Fed Governor Stephen Miran emphasized the need for aggressive interest rate cuts this year to sustain economic momentum. In contrast, Minneapolis Fed President Neel Kashkari expressed concerns that the unemployment rate could “pop” higher.
Richmond Fed President Tom Barkin, who is not a voting member on the rate-setting committee this year, highlighted the need for a measured approach, stating that any changes to rates should be finely tuned to incoming data due to the risks posed to both employment and inflation targets.
In the broader context, the US Dollar, known as the official currency of the United States and widely circulated in many other countries, accounts for over 88% of all global foreign exchange transactions, averaging around $6.6 trillion daily, as reported in 2022. Following World War II, the US Dollar emerged as the world’s reserve currency, displacing the British Pound. Historically, the Dollar was backed by gold until the Bretton Woods Agreement in 1971 effectively ended the Gold Standard.
The primary influence on the value of the US Dollar is the monetary policy dictated by the Federal Reserve, which has dual mandates to achieve price stability and foster full employment. The Fed adjusts interest rates as a key tool to fulfill these objectives. When inflation surges above the targeted 2%, the Fed raises rates, which typically bolsters the Dollar’s value. Conversely, in times of falling inflation or high unemployment, rate cuts tend to weigh on the currency.
In extreme circumstances, the Fed can resort to quantitative easing (QE) by increasing the money supply, usually to inject liquidity into a constricted financial system. This method was a critical tool during the Great Financial Crisis of 2008, facilitating the purchase of US government bonds from financial institutions. While QE generally weakens the Dollar, its opposite, quantitative tightening (QT), has a supportive effect on the currency, as it involves ceasing bond purchases and not reinvesting the principal from maturing bonds.
