US Dollar Index (DXY) recovers on Israel-Iran hostilities
- US Dollar Index (DXY) recovers as Middle East tensions lift the safe-haven appeal of the USD against its G10 peers.
- Trump pushes Iran to make a deal “before [it’s] too late” - Oil prices surge, posing a threat to the Fed.
- US Michigan Consumer Sentiment and Consumer Expectations ahead, but inflation pressure could start building if Oil prices remain high.
The US Dollar Index (DXY) is trading higher on Friday, with markets shifting focus on Israel’s war against Iran. With headlines arriving early Friday about Israel's attacks on Iran’s nuclear program and officials on Friday, the US Dollar (USD) rebounded off recent lows, gaining against its major counterparts.
The DXY, which measures the strength of the USD against a basket of currencies, has recovered above 98.00 at the time of writing. Although the US Dollar has received a slight boost from the hostilities in the Middle East, the DXY could continue to face pressure throughout the day.
On the economic agenda, investors are looking to the University of Michigan’s (UoM) Consumer Sentiment Index data and the UoM's 1-year and 5-year Consumer Inflation Expectations for June.
Middle East tensions rise, US Dollar gains, US involvement in question
Although inflation has been showing signs of slowing, with the Consumer Price Index (CPI) and Producer Price Index (PPI) data missing expectations this week, lower energy prices contributed to the move. Israel's launching this war could add pressure to energy prices. Oil prices are rallying following the attacks, which both US President Donald Trump and Israeli Prime Minister Netanyahu have confirmed that they are willing to continue.
In a post on social media, President Trump stated that "I gave Iran chance after chance to make a deal. I told them, in the strongest of words, to 'just do it,' but no matter how hard they tried, no matter how close they got, they just couldn’t get it done,".
These comments have raised questions over the involvement of the US in the attacks, which could cause geopolitical risks to intensify between the US and other nations that have condemned the attacks.
Multiple nations, including Saudi Arabia and China, have condemned Israel’s attack. Chinese foreign ministry spokesperson, Lin Jian, said that “China urges all relevant parties to do more to promote regional peace and stability and to avoid further escalation of the situation. China stands ready to play a constructive role in helping de-escalate the situation.”
The recent escalation could contribute to an increase in broader geopolitical risks, which may affect the US Dollar’s safe-haven appeal, thereby limiting the DXY’s ability to recover.
Additionally, if Oil and energy face shortages or disruptions from the tensions, prices could continue to rise, posing another threat to inflation.
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.