The value of the US Dollar can be affected by a number of different factors, such as the Central Regulator, also known as The Federal Reserve. The Central Bank and it’s monetary policy is known to have one of the largest effects on the exchange rate of the US Dollar and are entrusted with the stability of its price in accordance to the needs of the economy. Due to its importance and relation with the price movement of the Dollar, the market spends a large part of their fundamental analysis based around the Central Bank and its main figures. As part of this blog we will look at the relationship between the “Fed” and the Dollar, as well as the latest developments.
In the first part of this year the US Dollar has had a strong recovery after a largely bearish year. However, the US Dollar over the month of April has increasingly declined, even while taking into account the growing economy and improved employment figures released in the first week of April. For this reason, a lot of traders have been wondering why the US Dollar has decreased up to 2.75% this month alone. The price movement has many factors, some merely technical, however, largely the price movement has been affected by the stance of the Federal Reserve as well as comments made by the chairman.
The US Dollar is mainly priced based on supply and demand. The Federal Reserve is in charge of the supply of Dollars, and hence again is massively influential power. The Fed creates money through open market operations, i.e. purchasing securities in the market using new money, or by creating bank reserves issued to commercial banks. Bank reserves are then multiplied through fractional reserve banking, where banks can lend a portion of the deposits they have on hand.
In addition to the supply, the Regulator can also affect the demand of the US Dollar through: one interest rates, two comments regarding current and future economic conditions and lastly the bank’s Quantitative Easing programs. Why can comments which have no direct physical correlation with the US Dollar have an effect on the exchange rate? Firstly, investors tend to look for a stable economy and political system, comments made by the Chairman of the Bank regarding the economic stability can persuade investors and result in large market players steering clear.
How can interest rates affect the Dollar, or even simply just comments made regarding interest rates? Firstly, interest rates are used to control inflation and economic activity. Positive interest rates signal to investors that the economy is growing and stable. This is the first and easiest effect to understand as a beginner. Secondly, when interest rates are higher it results in investors to more likely receive higher returns on their investments within the US banking system. This results in more individuals, companies, banks and governments buying Dollars and overall increasing the level of demand.
So, where are interest rates currently at, and what is the Federal Reserve currently advising?
Currently, interest rates in the US are just above zero at 0.25% and they have been since the uncertainties brought about by COVID-19. The low interest rates have not necessarily been a significant strain so far as the majority of central banks around the world have also done the same. Whereas if the US was the only country, then yes this would significantly dampen demand. It should be noted that normally in the past the rate has been on average between 1.75% and 2.25%.
So, what is causing the US Dollar to decline over the past month? Well, we must remember the decline is not simply based on one factor, low treasury yields, risk appetite and a potential tax hike have also caused fluctuations in the price. However, one of the significant impacts is the Federal Reserve with their stance on future interest rates. As inflation starts to rise and employment starts to recover to more manageable levels, investors would have liked indications from the regulator that if the economic figures continue to improve, that interest rates may be on the raise towards the end of the year. However, the Chairman Mr. Powell, has stood firm that the improvement in the economy is not yet stable or significant enough for talks of interest rate hikes. In other words, investors will continue to receive a low return on their savings and investments.
The Regulator actually had spoken yesterday regarding the economy, as well as both the supply of the Dollar and interest rates. The Fed on Wednesday declined to let up on its easy money policy, despite an economy that it acknowledged is accelerating. As expected, the U.S. central Bank decided to keep short-term interest rates anchored near zero as it buys at least $120 billion of bonds each month (the regulators method of pumping more Dollars into the economy). The Chairman’s tone remained dovish and his tone had pushed the Dollar over the past few hours to a new two month low. Again, we can see here how the regulator has affected the world’s largest currency’s exchange rate.
It is important for traders to know why certain movements are happening and fundamental analysis is key as part of individuals overall analysis. However, technical and price analysis is also vital to traders in understanding the current price movements. Therefore, traders should keep in mind all three before determining how they may wish to position himself in the market.
