- Traders respond to new tariff comments from President Trump, overshadowing improved investor sentiment in stocks.
- The Fed’s data-driven stance remains intact, with market consensus leaning toward a possible rate cut in June.
- Bond yields are hovering around 4.60%, a sharp decline from last week’s highs, reflecting changing risk appetite.
- The US economic outperformance continues, but sudden policy shifts could weaken the dollar’s recovery efforts in the near term.
The US Dollar Index (DXY) is trading just above 108.00 and turns to losses if more selling pressure emerges. Tuesday’s trading was quiet as markets respond to comments late Monday from US President Donald Trump regarding tariffs on its North American neighbors.
Daily summary of market drivers: US dollar sees red despite Trump’s proposal to impose tariffs on Canada and Mexico
- Stocks rose slightly on Tuesday, with European stocks largely unchanged and US futures up about 0.50%.
- US bond yields are stable near 4.60%, well below last week’s levels. However, President Trump’s surprise trade policy announcements have sparked reversals in currency pairs and risk assets.
- Tariff talk points to a 25% tax on imports from Canada and Mexico by early February, which immediately put pressure on the Canadian dollar (CAD) and Mexican peso (MXN).
- The narrative of a strong dollar persists and many analysts view these trade moves as noise, believing that the underlying drivers of the ongoing rally including US economic dominance and steady Fed policy are the main drivers of the dollar’s upside.
- Fed media blackout precedes Chairman Powell’s January 29 press conference; Market prices for July are the earliest date for a single rate cut, depending on upcoming data.
- The CME FedWatch tool indicates a roughly 55% chance of no change in interest rates in May, meaning a rate cut in June if inflation moderates.
DXY Technical Outlook: Sellers fend off an attempt to reclaim the 20-day simple moving average
The US Dollar Index fell below the 20-day SMA near 108.50 and buyers’ efforts to reclaim this threshold proved unsuccessful. With the DXY still trading around the 108.00 area, fresh rejection at the 20-day SMA indicates growing downside risks. If sellers maintain their control, the US dollar could face a deeper decline despite broader fundamentals indicating resilience in the US economy. However, any signs of supportive trade or a shift in Fed expectations could quickly renew demand for the dollar.
Frequently asked questions about the US dollar
The US dollar (USD) is the official currency of the United States of America, and the “de facto” currency of a large number of other countries where it is traded alongside local banknotes. It is the most traded currency in the world, accounting for more than 88% of total global forex trading volume, or an average of $6.6 trillion in transactions per day, according to Data As of 2022. After World War II, the US dollar took the place of 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 disappeared.
The most important factor affecting the value of the US dollar is monetary policy, which is shaped by the Federal Reserve. The Fed has two missions: achieving price stability (controlling inflation) and promoting full employment. The basic tool for achieving these two goals is adjusting interest rates. When prices rise too quickly and inflation is above the Fed’s 2% target, the Fed will raise interest rates, which helps the value of the US dollar. When the inflation rate falls below 2% or when the unemployment rate is very high, the Fed may cut interest rates, which affects the dollar.
In extreme cases, the Fed could also print more dollars and activate quantitative easing (QE). Quantitative easing is the process by which the Federal Reserve dramatically increases the flow of credit into a stuck financial system. It is a non-standard policy measure used when credit dries up because banks will not lend to each other (due to fear of the counterparty defaulting). It is a last resort when simply lowering interest rates is unlikely to achieve the necessary result. It has been the Fed’s weapon of choice to combat the credit crunch that occurred during the Great Financial Crisis of 2008. This involves the Fed printing more dollars and using them to buy U.S. government bonds mostly from financial institutions. Quantitative easing usually weakens the US dollar.
Quantitative tightening (QT) is the reverse process whereby the Fed stops purchasing bonds from financial institutions and does not reinvest capital from bonds it holds outstanding in new purchases. It is usually positive for the US dollar.
