US Dollar Index (DXY) trims losses as fallout from US midterm elections settles

Losses in the US Dollar Index (DXY) narrow on Thursday as markets move past the immediate reaction to the US midterm election results.
The Greenback finds support in recent US figures showing a robust labour market alongside firm activity in services and manufacturing.
Confidence in a December Fed rate hike continues to discourage investors from building sizeable US Dollar short positions.

Selling pressure on the US Dollar (USD) is easing on Thursday, with markets turning from the US midterm election outcome towards this week’s robust US economic releases. The figures support the case for another Federal Reserve (Fed) interest rate increase in December. Having recovered from Asian-session lows of 101.20, the US Dollar Index (DXY) stands at 101.50 at the time of writing, leaving it virtually unchanged on the day.

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

A modest appetite for risk, against the backdrop of lower Oil prices and retreating US Treasury yields, continues to restrain any substantial US Dollar rebound. However, the latest US economic releases reinforce signs of strong economic momentum, helping to cushion declines in the USD.

Do stronger US labour figures and firm manufacturing and services activity support further tightening?

October’s ADP Employment report recorded a net addition of 86K jobs, exceeding the market forecast of 69K. Although the US ISM Services Purchasing Managers' Index eased to 54.5 in October from September’s 54.9, the reading continued to indicate solid activity in the sector. Its employment sub-index rose, while inflation held steady at elevated levels. Monday’s ISM Manufacturing PMI painted a comparable picture. Taken together, the releases suggest that the US economy entered the fourth quarter with strong momentum.

Expectations of a December Fed rate increase therefore remain strong, with the CME’s FedWatch Tool assigning an 81% probability to a quarter-point rise next month. Friday’s Nonfarm Payrolls (NFP) report remains in focus, although only a disastrous reading would change this assessment.

This assessment is shared by experts at some of the world’s leading commercial banks. Citing fundamentals that remain firm, MUFG analysts say they “would not interpret the post-election fall in US yields and the dollar as the beginning of a broad USD sell-off yet,” rather than viewing the move as a broader reversal. MUFG specifically notes that “US private payrolls rose by 86k in October, beating the 67k consensus and reinforcing signs of resilient labour demand following Tuesday’s stronger JOLTS print,” indicating that underlying support for the Dollar remains in place for now.

ING experts similarly see limited room for a deeper Dollar decline. In their view, “a still-resilient US economy and at least one more rate hike from the Federal Reserve” are likely to “limit a larger dollar correction.”

US Dollar: Common 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 alongside their 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 Bretton Woods Agreement in 1971 brought an end to the Gold Standard.

How does Federal Reserve policy affect 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, or controlling inflation, and promoting full employment are the Fed’s two mandates. Adjusting interest rates is its main means of pursuing these objectives. If prices increase too rapidly and inflation exceeds the Fed’s 2% target, it raises interest rates, supporting the USD. Conversely, inflation below 2% or an excessively high Unemployment Rate may prompt the Fed to cut rates, putting pressure on the Greenback.

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

The Federal Reserve can respond to extreme conditions by printing additional Dollars and introducing quantitative easing (QE). Through QE, the Fed sharply expands the supply of credit within a financial system that has stalled. This unconventional policy is used when credit dries up because banks, fearing counterparty defaults, refuse to lend to one another. It is a last resort when interest rate cuts alone are unlikely to deliver the required outcome. During the Great Financial Crisis in 2008, the Fed chose QE to tackle the credit crunch. Under this approach, it prints more Dollars to purchase US government bonds, mainly from financial institutions. The US Dollar typically weakens as a result of QE.

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

By contrast, quantitative tightening (QT) reverses this process: the Federal Reserve ceases bond purchases from financial institutions and allows its existing bonds to mature without reinvesting the principal in further purchases. This generally supports the US Dollar.