US Dollar Index gives up some gains, outlook remains firm as US Trump starts trade war
- The USD Index retraces after failing to revisit 110.00 but is still 0.7% higher intraday.
- US President Trump imposed 25% tariffs on Canada and Mexico, and 10% on China.
- Investors expect Trump’s tariffs would be inflationary for the US economy.
The US Dollar (USD) surrenders some of its intraday gains in Monday’s North American session, with the US Dollar Index (DXY), which tracks the Greenback’s value against six major currencies, dropping to near 109.20 after posting a fresh two-week high near 109.90.
The Greenback strengthened after United States (US) President Donald Trump imposed 25% tariffs on Canada and Mexico, and 10% on China. He also left the door open for tariffs on the Eurozone but didn’t provide much information. This scenario uplifted the US Dollar by increasing its safe-haven appeal.
Donald Trump had been warning that his North American peers and China could face hefty tariffs for allowing illegal immigrants and the deadly opioid fentanyl enter into the economy.
Market participants expect the imposition of bulky tariffs would lead to a global trade war. Such a scenario will be inflationary for the US economy, which would force the Federal Reserve (Fed) to maintain a restrictive monetary policy stance for longer.
Last week, the Fed left its key borrowing rates steady in the range of 4.25%-4.50% as officials were worried about stalling progress in the disinflation trend toward the central bank’s target of 2%. Fed Chair Jerome Powell guided that monetary policy adjustments would become appropriate only when they see “real progress in inflation or at least some weakness in the labor market”.
Going forward, investors will focus on the US ISM Manufacturing PMI data for January, which will be published at 15:00 GMT. The Manufacturing PMI is expected to come in at 49.8, slightly higher from 49.3 in December, but still will be below the 50.0 threshold that separates expansion from contraction.
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.
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