The US Dollar, the most heavily traded currency worldwide, commands over 88% of all global foreign exchange turnover, with average daily transactions soaring to $6.6 trillion. Recently, the US core Consumer Price Index (CPI) unexpectedly accelerated to 3.3% year-on-year, influencing monetary policy decisions by the Federal Reserve (Fed). This development has stirred expectations around the Fed's interest rate adjustments, a critical factor impacting the value of the US Dollar.
Historically, the US Dollar took over from the British Pound as the world's reserve currency post-World War II. This transition marked a pivotal shift in global economic dynamics. Initially backed by gold, the Dollar's value was pegged to gold until the Bretton Woods Agreement in 1971. Since then, it has relied on market dynamics and monetary policy.
The Federal Reserve plays a crucial role in shaping the economic landscape with its dual mandate: achieving price stability by controlling inflation and fostering full employment. To accomplish these goals, the Fed primarily adjusts interest rates. Typically, when inflation exceeds the Fed's 2% target, interest rates are raised to strengthen the US Dollar. Conversely, if inflation falls below this threshold or unemployment rises, the Fed may lower rates, pressuring the Greenback.
Quantitative easing (QE) is one of the tools employed by the Fed to increase credit flow in a stagnant financial system. This process often results in a weaker US Dollar. In contrast, quantitative tightening (QT) involves halting bond purchases and refraining from reinvesting matured bond principals, often leading to a stronger Dollar.
The recent increase in the US core CPI has spurred discussions around potential rate hikes. A higher inflation rate of 3.3% suggests that prices are rising faster than anticipated, prompting expectations of interest rate adjustments by the Fed. Such measures could bolster the US Dollar's strength in global markets.
The importance of monetary policy cannot be overstated when assessing the value of the US Dollar. The Fed's decisions regarding interest rates significantly influence its value. As prices rise rapidly, exceeding the Fed's 2% target, raising rates becomes essential to maintain economic stability and bolster the Dollar's standing.
Trade policies also play a role in currency valuation. Recently, the US President imposed a 25% tariff on steel and aluminum imports, impacting the Canadian Dollar. Tariffs can influence trade balances and affect currency values, further emphasizing the complex interplay between economic policies and currency markets.