Weak tech earnings weigh on United States Dollar Index

Disappointing megacap earnings have raised doubts over the sustainability of the AI trade, putting pressure on the US Dollar Index.
Alternative safe-haven currencies gained as the Middle East conflict intensified and the prospect emerged of US-Israeli strikes on Iran after the midterm elections.
Despite high market-implied odds of another rate increase, Fed Chair Kevin Warsh indicated no pressing need for further policy tightening.

101.60 is the level around which the US Dollar Index (DXY) is trading in Friday’s Asian session. The index, which tracks the US Dollar (USD) against six major currencies, remains subdued for a fourth consecutive day.

TMGM Analysis: Financial Market News, Economic Calendar & Market Insights

Doubts over the durability of the AI trade continued to weigh on the Greenback. Several megacap technology companies reported quarterly earnings below expectations, undermining investor confidence.

Risk aversion has spread across markets as geopolitical hostilities in the Middle East intensify. Reports suggest the US and Israel are preparing further military strikes on Iran after the forthcoming midterm elections. The prospect has strengthened demand for safe havens, lifting the Japanese Yen and Swiss Franc against the Greenback.

Federal Reserve (Fed) officials, meanwhile, have shown little appetite for speeding up monetary tightening. Although Fed Chair Kevin Warsh recently voiced confidence in the US economy’s underlying resilience, he gave no indication of whether further interest rate increases would be necessary. Despite that measured message, pricing tracked by the CME FedWatch Tool currently assigns a 92.8% probability to rates remaining unchanged at the October 27–28 policy meeting.

Short-end yields underpin Dollar as defensive FX outperformance is expected

A shift away from higher-beta currencies is evident in the current environment, according to ING analysts, who say it “probably favours a little more outperformance of the defensive currencies over commodity currencies,”. Their caveat is that “until the rock-solid short-end of the US yield curve starts to buckle, it is hard to make the case that the Dollar needs to fall across the board,”. Firm US front-end yields therefore remain an important source of broad Dollar support, even as relative performance across G10 FX starts to favour more defensive currencies.

US Dollar: Key Questions

The US Dollar: what role does it play?

The United States of America’s official currency is the US Dollar (USD). It also serves as the ‘de facto’ currency in a significant number of other countries, circulating alongside domestic banknotes. No other currency is traded more heavily worldwide. According to 2022 data, it accounts for over 88% of global foreign exchange turnover, equivalent to average daily transactions of $6.6 trillion. After the Second World War, the USD replaced the British Pound as the world’s reserve currency. Gold backed the US Dollar for most of its history, until the Bretton Woods Agreement in 1971 marked the end of the Gold Standard.

Federal Reserve decisions: what drives their effect on the US Dollar?

Monetary policy is the single biggest influence on the US Dollar’s value. The Federal Reserve (Fed) sets that policy under a dual mandate: maintaining price stability by controlling inflation and promoting full employment. Adjustments to interest rates are its main means of pursuing both objectives. If prices climb too rapidly and inflation exceeds the Fed’s 2% target, the central bank raises rates, supporting the USD. Conversely, inflation below 2% or an excessively high Unemployment Rate may prompt rate cuts, putting downward pressure on the Greenback.

Quantitative Easing: how does it affect the US Dollar?

When conditions become extreme, the Federal Reserve can create additional Dollars and introduce quantitative easing (QE). Through QE, the Fed substantially expands credit flows within a financial system that has become blocked. This unconventional policy addresses a credit drought caused by banks refusing to lend to one another for fear of counterparty default. It is a last resort when interest rate cuts alone are unlikely to deliver the required outcome. During the Great Financial Crisis in 2008, QE was the Fed’s preferred response to the credit crunch. The central bank creates more Dollars and uses them to purchase US government bonds, mainly from financial institutions. The US Dollar typically weakens as a result of QE.

Quantitative Tightening: what does it mean for the US Dollar?

The opposite of quantitative easing is quantitative tightening (QT). Under QT, the Federal Reserve ceases bond purchases from financial institutions and does not reinvest the principal from maturing bond holdings in new purchases. This process generally supports the US Dollar.