• US Dollar Index gains ground as elevated oil prices exacerbate inflation concerns, favoring further Fed tightening.
• Stalled US-Iran talks push US 10- and 30-year Treasury yields above 5%.
• Markets price in a 70% chance of an October rate increase ahead of critical PCE and payrolls data.

The US Dollar Index (DXY), which measures the value of the US Dollar (USD) against six major currencies, is extending its gains for the second successive day and trading around 101.20 during Asian hours on Tuesday.

The Greenback gained support as ongoing uncertainty surrounding US-Iran negotiations kept oil prices elevated. This persistent pressure on energy costs has heightened expectations that the Federal Reserve will need to tighten monetary policy further to combat inflation.

The surge in oil prices resumed after Iranian officials expressed doubt about reaching an agreement prior to the upcoming US midterm elections in November. The standstill follows US President Donald Trump’s recent rejection of Tehran’s latest proposal, which stalled diplomatic momentum.

Rising inflation concerns and expectations of additional rate increases pushed Treasury yields to fresh multi-year highs, with both the 10- and 30-year yields climbing above 5%. Following the central bank’s initial rate hike in three years earlier this month, the CME FedWatch Tool shows money markets are currently pricing in roughly a 70% probability of another Federal Reserve rate increase in October.

USD positioning steady as Rabobank flags balanced build-up in longs and shorts

Analysts at Rabobank observe that speculative positioning in the Dollar has shown little net change, with “USD net longs are largely unchanged as both long and short positions increased by 2,000 positions, respectively.” This underscores a broadly balanced adjustment in market exposure, even as investors continue to reassess the Fed policy outlook.

Market attention now shifts toward upcoming US economic indicators for signals regarding future monetary policy. Key releases later this week include Wednesday’s US Personal Consumption Expenditures (PCE) inflation report and Friday’s Nonfarm Payrolls report.

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.