US Dollar remains supported by Fed policy outlook and geopolitical tensions, experts agree

Buying interest lifts the US Dollar Index above 102.00 to new two-week highs, following a 0.6% gain over three days.
Demand for the US Dollar revives as investors prepare for the Fed to leave rates unchanged with a hawkish stance on Wednesday.
The safe-haven USD draws further support as expectations of an immediate US-Iran peace agreement fade.

Strong demand has placed the US Dollar among the best-performing major currencies in recent sessions, as investors await next Wednesday’s Federal Open Market Committee (FOMC) decision. Tracking the US Dollar (USD) against a basket of six other currencies, the US Dollar Index (DXY) has advanced more than 0.6% across the last three trading days, reaching two-week highs above 102.00.

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

With markets preparing for a hawkish pause by the Federal Reserve (Fed), traders have taken long positions in the US Dollar this week. Such an outcome would confirm expectations of a quarter-point rate increase in December. Meanwhile, the latest effort to ease Middle East tensions has, like earlier attempts, produced no result. Continuing clashes between regional powers and attacks in the Strait of Hormuz are also underpinning the USD’s appeal as a safe haven.

Can Dollar Support Strengthen Before the Key Fed Decision?

ING’s Chris Turner sees support for the dollar on pullbacks, noting that with “energy prices firm and expectations growing that the US and Israel will launch another attack on Iran (...) we expect central banks to stay hawkish. This should keep the dollar supported on dips.”

HSBC analysts share a similar view, saying they "expect the USD to consolidate near its recent highs over the coming weeks, with risks tilted towards further gains rather than material weakness."

Nevertheless, HSBC maintains a more neutral outlook for the USD. Its experts argue that "US economic resilience, a hawkish Federal Reserve and potential challenges for other currencies should limit the USD’s downside, without necessarily providing the momentum for another leg higher."

Persistent inflation risks also lead TD Securities to anticipate a cautious stance from the FOMC following Wednesday’s meeting. The TD Securities expert puts it this way: “A hold in October will make a December hike all the more likely,”

Why Are Eurozone Credit Strains Supporting USD Demand?

Brown Brothers Harriman strategists highlight the findings of the ECB’s October survey, which “showed a further net tightening of credit standards and weaker loan demand in Q3,”. They say this combination “is a headwind to Eurozone economic activity and challenges the nearly 75bps of ECB hikes priced by markets over the next twelve months.”

For the US, BBH expects the upcoming data to demonstrate continued economic strength, saying “September durable goods orders and ADP weekly employment change will likely underscore the resilience of the economy,”. The firm also notes that “rising gasoline prices point to worsening near-term inflation expectations in October’s consumer confidence survey.” Taken together, these factors strengthen the argument for the Fed to maintain a firm monetary policy stance.

US Dollar: Frequently Asked Questions

What role does the US Dollar play?

Alongside being the official currency of the United States of America, the US Dollar (USD) serves as the ‘de facto’ currency in a significant number of other countries, circulating together with local banknotes. No other currency is traded more widely: according to 2022 data, it accounts for over 88% of global foreign exchange turnover, equivalent to average daily transactions of $6.6 trillion. The USD replaced the British Pound as the world’s reserve currency after the Second World War. Gold backed the US Dollar for most of its history, until the Gold Standard ended with the Bretton Woods Agreement in 1971.

How does Federal Reserve policy affect the US Dollar?

Monetary policy, determined by the Federal Reserve (Fed), is the single biggest influence on the US Dollar’s value. The Fed’s twin mandates are price stability, which involves controlling inflation, and full employment. Adjusting interest rates is its main means of pursuing these objectives. If prices climb too rapidly and inflation exceeds the Fed’s 2% target, the central bank raises rates, helping to support the USD. Conversely, inflation below 2% or an excessively high Unemployment Rate may prompt the Fed to cut interest rates, putting pressure on the Greenback.

How does Quantitative Easing work, and what does it mean for the US Dollar?

When conditions become extreme, the Federal Reserve may print additional Dollars and introduce quantitative easing (QE). Through QE, the Fed sharply expands the supply of credit in a financial system that is no longer functioning effectively. This unconventional policy is used when credit dries up as banks refuse to lend to one another for fear that counterparties will default. It serves as 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. Under this approach, the central bank prints more Dollars to purchase US government bonds, mainly from financial institutions. The usual effect of QE is a weaker US Dollar.

How does Quantitative Tightening work, and what does it mean for the US Dollar?

By reversing quantitative easing, quantitative tightening (QT) typically supports the US Dollar. Under QT, the Federal Reserve ceases bond purchases from financial institutions and does not use the principal repaid on its maturing bond holdings to make new purchases.