The US Dollar Index (DXY), which tracks the Greenback against a basket of currencies, kicks off the new week on a positive note, though it lacks follow-through and remains below Friday’s swing high. The index currently trades around the 99.65 region, up 0.15% for the day.
The global risk sentiment remains fragile on the back of a further escalation of tensions in the Middle East, which, in turn, is seen as a key factor that continues to underpin the US Dollar’s (USD) status as the global reserve currency. In the latest developments, US President Donald Trump issued a 48-hour deadline for Iran to reopen the Strait of Hormuz and threatened to target Iran’s energy infrastructure if the demand is not met.
Iran responded by threatening to escalate strikes on energy infrastructure and target critical water desalination facilities across the Middle East, should Trump make good on a promise to “obliterate” the country’s power plants. This remains supportive of elevated Crude Oil prices, fueling inflationary concerns and forcing investors to dial back expectations for rate cuts by the US Federal Reserve (Fed) in 2026. This further supports the USD.
Meanwhile, the US central bank last week projected one rate reduction this year. In contrast, major central banks around the world signaled the potential for rate hikes to quell renewed inflationary pressures. This, in turn, is holding back the USD bulls from placing aggressive bets and acting as a headwind for the DXY. The mixed fundamental backdrop, however, warrants some caution before positioning for a firm near-term direction.
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.
