Why is the United States Dollar Index staying firm amid oil-driven inflation and Fed neutrality?

Gains in the US Dollar Index come as higher oil prices intensify global inflation risks.
Markets assign an 83.9% probability to rates remaining unchanged next week, according to the FedWatch Tool.
Uncertainty persists ahead of the October policy meeting as Fed Chair Warsh declines to prejudge decisions.

Safe-haven demand is supporting the US Dollar (USD) as climbing oil prices fuel concerns over global inflation, helping the currency retain its recent gains. During Wednesday’s Asian trading hours, the US Dollar Index (DXY) is edging up near 101.80, extending the previous day’s modest advance. The index tracks the USD against a basket of six major currencies.

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

Mixed signals on diplomatic engagement between the United States (US) and Iran kept traders cautious as crude prices climbed. Talks are still under way, but sentiment came under pressure after high-level meetings in Tehran. Pakistan’s army chief, Field Marshal Asim Munir, held discussions with senior Iranian diplomatic and military leaders on bilateral relations and the progress of talks with Washington. According to a diplomat involved in the discussions, efforts to resolve the conflict continue, but reports suggesting that a final agreement is imminent are premature.

Expectations for the Federal Reserve’s (Fed) next policy steps remain under close scrutiny in financial markets. The CME FedWatch Tool puts the market-implied probability of unchanged interest rates next week at 83.9%, while traders assign a 90% chance to a rate increase in December. Fed Chair Kevin Warsh, however, retained a neutral position, stressing that he does not "prejudge" interest rate decisions. His remarks provided no firm indication of whether the central bank would increase rates or leave them unchanged at the forthcoming October policy meeting.

Could a tech sell-off add to pressure on the USD?

Currency markets could become increasingly sensitive to developments in equities, Scotiabank strategists warn. They argue 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.” Sustained weakness across technology shares could, in their assessment, erode a key source of support for the Dollar. That would reinforce the prevailing broad-based USD softness as markets reconsider the prospects of near-term Fed tightening.

US Dollar: key questions answered

What role does the US Dollar play?

Alongside its status as 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 alongside their local banknotes. No other currency is traded more heavily worldwide. Data from 2022 show that 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 Gold Standard ended with the Bretton Woods Agreement in 1971.

Why do Federal Reserve decisions matter for the US Dollar?

Monetary policy, set by the Federal Reserve (Fed), is the single biggest influence on the US Dollar’s value. Achieving price stability by controlling inflation and promoting full employment are the Fed’s two mandates. Interest rate adjustments are its main means of meeting both objectives. If prices climb too rapidly and inflation exceeds the Fed’s 2% target, the central bank will increase rates, supporting 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 affect the US Dollar?

When conditions become extreme, the Federal Reserve can print additional Dollars and implement quantitative easing (QE). Through QE, the Fed substantially expands the supply of credit in a financial system that is no longer functioning smoothly. This unconventional policy is used when credit dries up because banks, fearing counterparty defaults, are unwilling to lend to one another. It serves as a last resort if 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 process entails printing more Dollars to purchase US government bonds, mainly from financial institutions. A weaker US Dollar is the usual result of QE.

How does Quantitative Tightening affect the US Dollar?

In quantitative tightening (QT), the process is reversed: the Federal Reserve halts bond purchases from financial institutions and allows its existing bonds to mature without reinvesting the principal in new purchases. This generally supports the US Dollar.