• US Dollar Index gains amid rising oil prices heighten global inflation risks.
• FedWatch Tool suggests that markets price in an 83.9% chance of a rate pause next week.
• Fed Chair Warsh refuses to prejudge decisions, offering no clear signal ahead of the October policy meeting.

The US Dollar Index (DXY), which measures the value of the US Dollar (USD) against six major currencies, is inching higher after posting modest gains in the previous day and trading near 101.80 during the Asian hours on Wednesday. The Greenback holds its recent gains as rising oil prices heighten global inflation concerns and boost demand for safe-haven assets.

Crude prices advanced as traders carefully evaluated mixed signals regarding diplomatic engagements between the United States (US) and Iran. Although negotiations remain active, market sentiment faced headwinds following high-level meetings in Tehran, where Pakistan’s army chief, Field Marshal Asim Munir, met with senior Iranian diplomatic and military leaders to discuss bilateral ties and the status of talks with Washington. A diplomat involved in the discussions clarified that while conflict resolution efforts are ongoing, reports of an imminent final agreement are premature.

On the monetary policy front, financial markets are closely gauging the Federal Reserve's (Fed) next moves. According to the CME FedWatch Tool, traders currently price in an 83.9% probability that the Fed will keep interest rates on hold next week, alongside a 90% chance of a rate hike in December. However, Fed Chair Kevin Warsh maintained a neutral stance, emphasizing that he does not "prejudge" interest rate decisions and leaving markets without a definitive signal on whether the central bank will raise or hold rates steady at its upcoming October policy meeting.

Tech shakeout seen as fresh headwind for the USD

Scotiabank strategists caution that equity market dynamics could increasingly feed back into the currency space, arguing that “a deeper shakeout in tech stocks could become a further headwind for the USD, given the dominance of the AI build-out in the US growth/inflation narrative.” In their view, any sustained pressure on the technology complex would risk undermining one of the key themes that has supported the Dollar, reinforcing the current backdrop of broad USD softness as markets reassess near-term Fed tightening risks.

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.

Akhtar Faruqui is a Forex Analyst based in New Delhi, India. With a keen eye for market trends and a passion for dissecting complex financial dynamics, he is dedicated to delivering accurate and insightful Forex news and analysis.