US Dollar Index (DXY) pares losses as the dust from the US midterm elections settles
- US Dollar Index (DXY) pares losses on Thursday as the dust from the US midterm elections settles.
- Recent US data depicts a strong labour market with solid services and manufacturing activity, which is providing support to the Greenback.
- Markets remain confident that the Fed will hike rates in December, another reason to deter investors from placing large US Dollar shorts.
The US Dollar (USD) is reversing previous losses on Thursday as markets start to shift their gaze away from the results of the US midterm elections to the solid US macroeconomic figures released this week, which pave the path for another Federal Reserve (Fed) interest rate hike in December. The US Dollar Index (DXY) is trading at 101.50 as of writing, practically flat on the daily chart, after bouncing from 101.20 lows during the Asian session.
A mild appetite for risk amid the recent decline in Oil prices and the pullback in US Treasury yields is still acting as headwinds for any significant US Dollar recovery, but recent US economic data has added to the evidence of strong economic momentum and is acting as a cushion for USD dips.
US labour data beats expectations with manufacturing and services showing solid activity
The ADP Employment report showed an 86K increase in net jobs in October, beating market expectations of a 69K reading. US ISM Services Purchasing Managers' Index showed a moderate slowdown to 54.5 in October, from 54.9 in September, but still at levels consistent with a solid sector’s activity, with the employment sub-index increasing and inflation steady at high levels. The ISM Manufacturing PMI showed a similar picture on Monday, all in all suggesting that the US economy started the fourth quarter on a strong pace.
Against this background, bets for a Fed interest rate hike in December remain high. The CME’s FedWatch Tool shows an 81% chance of a quarter-point hike next month. The market remains attentive to Friday’s Nonfarm Payrolls (NFP) report, but it would require a disastrous reading to alter this view.
Experts at some of the world's major commercial banks share this scenario. Analysts at MUFG affirm that they “would not interpret the post-election fall in US yields and the dollar as the beginning of a broad USD sell-off yet,” pointing instead to still-solid fundamentals. In particular, MUFG highlights that “US private payrolls rose by 86k in October, beating the 67k consensus and reinforcing signs of resilient labour demand following Tuesday’s stronger JOLTS print,” suggesting underlying support for the Dollar remains intact for now.
In a similar vein, ING experts argue that the scope for a deeper setback in the Dollar remains constrained, with “a still-resilient US economy and at least one more rate hike from the Federal Reserve” likely to “limit a larger dollar correction.”
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.