The US Dollar Index (DXY), an index of the value of the US Dollar (USD) measured against a basket of six world currencies, trades on a softer note around 98.70 during the early Asian session on Tuesday. The DXY edges lower on the prospect of a US interest rate cut. The Federal Reserve (Fed) interest rate decision will take center stage on Wednesday.
The Fed is widely expected to lower interest rates by another quarter point, bringing the benchmark rate to 3.75-4.00%, at its October meeting on Wednesday. The markets are now pricing in nearly a 97% chance of a quarter of a percentage point rate reduction at the Fed’s October meeting, according to the CME FedWatch tool.
The US government shutdown has sparked debate among Fed officials. Policymakers are weighing whether to reduce rates quickly to boost a weakening labor market or keep rates steady in the face of inflation that remains stubbornly above the Fed 2% target. The attention will shift to the press conference following the rate decision. Any dovish comments from Fed Chair Jerome Powell could drag the US Dollar lower against its rivals.
US Treasury Secretary Scott Bessent said on Sunday that the US and China both reached a preliminary consensus on key issues, including export controls, fentanyl trafficking, agricultural trade, and shipping levies. The talks paved the way for US President Donald Trump and his Chinese counterpart Xi Jinping to finalize a deal during their meeting in South Korea later on Thursday. Optimism over a possible US-China trade deal could lift the US Dollar in the near term.
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.
