The US Dollar (USD) extends its recovery on Wednesday, supported by comments from the Federal Reserve (Fed) Bank of Minneapolis President Neel Kashkari, who spooked markets on Tuesday. Kashkari suggested that a rate hike could still be a possibility this year. Markets ignored that Kashkari is a non-voter this year and can thus speak a little bit more freely and personally, together with his closing remark that he does not see a hike as a possible outcome for now.
On the economic data front, Wednesday’s focus is on the Richmond Fed Manufacturing index for May. Markets have already seen the Dallas Fed Manufacturing number sink further to -19.4 in May from -14.5. Another lower-than-expected Manufacturing Index could mean more easing ahead for the Greenback, with markets rejecting completely the rate hike possibility from Kashkari.
The US Dollar Index (DXY) played with fire on Tuesday after testing the lower and last support level in the current range. The 100-day Simple Moving Average (SMA) did its part around 104.34, and sent the DXY in a turnaround back up above 104.50. The question will be how long it will last, with the focus shifting to the Q1 US Gross Domestic Product (GDP) second estimate numbers on Thursday and the Personal Consumption Expenditures (PCE) Price Index for April on Friday.
On the upside, the DXY index needs to reclaim key levels it lost last week: the 55-day Simple Moving Average (SMA), currently at 104.82, and the 105.00 big round level. Further up, the following levels to consider are 105.12 and 105.52.
On the downside, the 200-day SMA at 104.42 and the 100-day SMA around 104.34 are the last line of defence. Once that level snaps, an air pocket is placed between 104.30 and 103.00. Should the US Dollar decline persist, the low of March at 102.35 and the low from December at 100.62 are levels to consider.
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.