US Dollar Index softens to near 98.00 as Fed rate cut bets grow

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The US Dollar Index (DXY), an index of the value of the US Dollar (USD) measured against a basket of six world currencies, edges higher to around 98.15 during the Asian session on Friday. The US August employment report will be the highlight later on Friday.

US Dollar Index weakens to near 98.15 in Friday’s Asian session.
The softer job data reinforced expectations that the Fed will cut rates this month.
All eyes will be on the US August employment report later on Friday.

The number of Americans filing new applications for jobless benefits increased more than expected last week, consistent with softening labor market conditions. Additionally, US private sector employment rose by 54,000 in August, according to Automatic Data Processing (ADP). This figure followed a 106K (revised from 104K) increase seen in July and came in below the expectation of 65K.

Traders raise their bets that the US Federal Reserve (Fed) will cut rates this month, which undermines the DXY. Markets are currently pricing in a nearly 100% chance of the Fed cutting interest rates later this month, up from 87% a week ago, according to the CME FedWatch tool.

Federal Reserve Bank of New York President John Williams said on Thursday that he expects gradual interest rate cuts over time if the economy meets forecasts. However, Williams added that the central bank must balance inflation and job market risks right now. Meanwhile, Chicago Fed President Austan Goolsbee said on Friday that the US labor market might be deteriorating, adding that there is a bit of wait-and-see amid uncertainty.

Traders will take more cues from the US employment report for August, which is due later on Friday. The US economy is forecast to see 75,000 jobs added in August, while the Unemployment Rate is projected to edge up to 4.3% during the same period. The weaker-than-expected NFP print could lead to a bearish reaction in the US Dollar. On the other hand, a stronger-than-expected outcome could help limit the DXY’s losses as it raises the central bank’s scope to keep interest rates higher for longer.

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.