The US Dollar Index (DXY), which measures the value of the USD against a basket of six currencies, is declining on Friday as profit-taking sets in following a strong rally earlier in the month. The US Dollar retreat comes ahead of a series of speeches by Fed officials on Friday, which could provide further insight into the central bank's monetary policy stance. Additionally, US housing data released on Friday morning showed a decrease in Building Permits and Housing Starts, indicating a potential slowdown in the housing market.
Despite a period of deceleration, the economy has demonstrated signs of strength, and the Federal Reserve (Fed) has indicated that its approach to monetary policy will be guided by the evolving economic data.
The DXY index faced resistance at the 200-day SMA, leading to a period of consolidation. The Relative Strength Index (RSI) and Moving Average Convergence Divergence (MACD) have flattened in positive territory, indicating neutral momentum. As expected, the DXY might enter into a correction period after a furious rally, which took the index from 100.30 to near 104.00.
Supports are located at 103.50, 103.30 and 103.00, while resistances lie at 103.80, 104.00 and 104.30.
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.