• US Dollar Index declines after September housing starts declined and pending home sales hit record lows, highlighting US economic weakness.
• Surging oil prices driven by Middle East and Russia-Ukraine drone strikes could boost inflation and rate-hike expectations.
• ING reports investors are questioning the "higher-for-longer" rate narrative as long-end market expectations adjust downward.

The US Dollar Index (DXY), which measures the value of the US Dollar (USD) against six major currencies, is remaining subdued for the third consecutive day and trading near 101.50 during the European hours on Thursday.

The Greenback faces challenges as recent economic data pointed to signs of weakness in the US economy, with September housing starts declining and pending home sales falling to a record low. According to the CME FedWatch Tool, traders are pricing in an 84% probability that the Fed will hold interest rates steady next week, alongside a 90% chance of a rate hike in December. However, uncertainty persists after Fed Chair Kevin Warsh refrained last week from offering guidance on the timing or necessity of future interest rate hikes.

However, the US Dollar may receive support as surging oil prices fuel inflation fears and boost expectations of a Federal Reserve (Fed) rate hike. Oil prices advanced following a drone attack on Saudi Aramco’s Shaybah oil field that resulted in two casualties, intensifying geopolitical friction in the Middle East and raising concerns over potential energy supply disruptions. In tandem, Ukraine executed large-scale drone strikes against critical Russian oil infrastructure this week, signaling Kyiv's intent to impede Moscow's planned expansion of diesel exports under a recent agreement between Presidents Trump and Putin.

Rate markets reassess ‘higher for longer’ as long-end reprices

Analysts at ING highlight that a “subtle change in the rate markets” is underway. They note that during late summer, and particularly in September, higher energy prices had been closely associated with a “'higher rates forever'” narrative, pushing the one-month USD OIS priced 10 years forward to “5.17% – miles away from any neutral rate near 3.50%.” ING now sees those views “changing,” with the recent repricing at the long end suggesting investors are starting to question the durability of that earlier higher-for-longer stance.

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.