The US Dollar (USD) is outmatching other currencies on Wednesday for the second day in a row with some help from US Federal Reserve (Fed) officials, who seem to have turned more hawkish. Federal Reserve Governor Michelle Bowman lit the fire on the fuzz by saying that a rate hike is still an option while she sees too many potential risks that could still drive inflation higher. Her thesis became reality just a few hours later, after neighbouring country Canada released red-hot inflation numbers.
On the economic front, a rather light calendar ahead of ThursdayÂ’s Gross Domestic Product (GDP) final estimate and FridayÂ’s Personal Consumption Expenditures (PCE) Price Index release. Still, traders will need to watch out for the Bank Stress Test report, to be published at 20:30 GMT, in which the Fed analyzes how healthy US banksÂ’ balance sheets are in case of financial market distress.Â
The US Dollar Index (DXY) is rolling for a second day in a row, and is breaking out of its sideways pattern. The DXY is now trading just below the high of May and could rally further, should upcoming US data outperform again. Clearly the recent hawkish messages from Fed officials are spooking markets in the fear of having missed out on any signals that would signal an uptick in inflation is again at hand.Â
On the upside, the first level to watch is 105.88, which triggered a rejection at the start of May and on Friday last week. Further up, the biggest challenge remains at 106.52, the year-to-date high from April 16. A rally to 107.20, a level not seen since April 2023, would need to be driven by a surprise uptick in US inflation or a sudden hawkish shift from the Fed.Â
On the downside, 105.52 is the first support ahead of a trifecta of Simple Moving Averages (SMA). First is the 55-day SMA at 105.23, safeguarding the 105.00 round figure. A touch lower, near 104.66 and 104.48, both the 100-day and the 200-day SMA form a double layer of protection to support any declines. Should this area be broken, look for 104.00 to salvage the situation.Â
Monetary policy in the US is shaped by the Federal Reserve (Fed). The Fed has two mandates: to achieve price stability and foster full employment. Its primary tool to achieve these goals is by adjusting interest rates. When prices are rising too quickly and inflation is above the FedÂ’s 2% target, it raises interest rates, increasing borrowing costs throughout the economy. This results in a stronger US Dollar (USD) as it makes the US a more attractive place for international investors to park their money. When inflation falls below 2% or the Unemployment Rate is too high, the Fed may lower interest rates to encourage borrowing, which weighs on the Greenback.
The Federal Reserve (Fed) holds eight policy meetings a year, where the Federal Open Market Committee (FOMC) assesses economic conditions and makes monetary policy decisions. The FOMC is attended by twelve Fed officials – the seven members of the Board of Governors, the president of the Federal Reserve Bank of New York, and four of the remaining eleven regional Reserve Bank presidents, who serve one-year terms on a rotating basis.
In extreme situations, the Federal Reserve may resort to a policy named 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 during crises or when inflation is extremely low. It was the FedÂ’s weapon of choice during the Great Financial Crisis in 2008. It involves the Fed printing more Dollars and using them to buy high grade bonds from financial institutions. QE usually weakens the US Dollar.
Quantitative tightening (QT) is the reverse process of QE, whereby the Federal Reserve stops buying bonds from financial institutions and does not reinvest the principal from the bonds it holds maturing, to purchase new bonds. It is usually positive for the value of the US Dollar.
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