US Dollar Index advances on Middle East escalation and steady Fed outlook

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The US Dollar Index (DXY), which tracks the Greenback’s value against a basket of six major currencies, extends its advance on Monday, climbing back toward the ten-month highs reached earlier this month as demand for the US Dollar (USD) remains firm amid escalating tensions in the Middle East.

The US Dollar Index extends its rally as Middle East tensions intensify.
Oil supply disruptions keep inflation concerns elevated as growth risks emerge.
Interest rate outlook shifts as traders pare back Fed rate hike expectations.

At the time of writing, the index trades near 100.50, remaining on the front foot for a fifth consecutive day.

The US-Israel war with Iran shows no signs of easing despite reports of ongoing negotiations, with Iran-backed Houthi forces now joining the conflict, raising fears of a broader regional escalation.

At the same time, reports suggest the Pentagon is preparing for weeks of ground operations in Iran, with thousands of US troops being deployed to the region, signaling the risk of a prolonged conflict.

US President Donald Trump said on Monday that “great progress” has been made in talks with Iran and that a deal will “probably” be reached. He warned, however, that the US would “completely obliterate” Iran’s power infrastructure, oil wells and Kharg Island if negotiations fail, adding that Washington is in serious discussions with a “new and more reasonable” regime to end military operations.

As the conflict widens, Oil supply disruptions remain in focus, with rising prices feeding into inflation concerns. However, markets are increasingly shifting their focus toward risks to economic growth.

Since the US-Iran war erupted, rate expectations have shifted sharply. Oil-driven inflation initially led markets to price in potential Federal Reserve (Fed) rate hikes, but rising growth concerns are now prompting traders to scale back those bets, driving a pullback in US Treasury yields on Monday.

According to the CME FedWatch Tool, markets now expect the Fed to keep interest rates steady at 3.50%-3.75% through 2026.

Fed Chair Jerome Powell said on Monday that policy is “in a good place” to wait and assess how the current situation unfolds, noting uncertainty around the economic impact. He reaffirmed that the Fed remains committed to bringing inflation back to its 2% target on a sustained basis.

Looking ahead, markets will focus on upcoming US economic data, including the Manufacturing Purchasing Managers’ Index (PMI) and the Nonfarm Payrolls (NFP) report later this week.

US Dollar FAQs

What is the US Dollar?

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.

How do the decisions of the Federal Reserve impact the US Dollar?

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.

What is Quantitative Easing and how does it influence the US Dollar?

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.

What is Quantitative Tightening and how does it influence the 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.