US Dollar Index softens to near 99.00 amid US-Iran conflict risks

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US Dollar Index posts modest losses around 99.10 in Wednesday’s early European session.
The US said it struck boats and missile sites in Iran.
Growing expectations of tighter monetary policy could support the US Dollar.

The US Dollar Index (DXY), an index of the value of the US Dollar (USD) measured against a basket of six world currencies, currently trades near 99.10 during the early European trading hours on Wednesday. The DXY trades with mild losses as traders weigh the risks of a renewed flare-up in the Iran war.

Reuters reported on Tuesday that Iranian officials said the US had violated a ceasefire by attacking targets near the contested Strait of Hormuz, potentially complicating efforts to bring the war to a close. Iranian Supreme Leader Mojtaba Khamenei said that Gulf powers will no longer be a shield for US bases, and the US will no longer have a safe haven in the region.

Traders will closely monitor the developments surrounding the US-Iran peace deal. US President Donald Trump stated early Tuesday that negotiations with Iran to extend their ceasefire and reopen the crucial waterway are proceeding. However, uncertainty remains high as disputes over language concerning Iran’s nuclear program and sanctions have held up a deal.

A hawkish shift in interest rate hike expectations, driven by rising oil prices, could underpin the DXY in the near term. Traders are now pricing in nearly a 39.0% probability that the Federal Reserve (Fed) will raise interest rates by 25 basis points (bps) by year-end, according to the CME FedWatch tool.

The US April Personal Consumption Expenditures (PCE) Price Index report will take center stage later on Thursday. If the report shows hotter-than-expected inflation outcomes, this could lift the USD against its rivals.

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.