Currency – US Dollar (USD)
The United States of America is the world’s largest economy and so its economy plays a major role in the global markets. Its currency, the US dollar, also known as the greenback, is the most liquid currency in the world and it is used as a reserve currency by many countries. It is deemed to be the King of Currencies.
First of all, you should remember that trading is done in currency pairs. The most actively traded currency pairs include the USD. Take a look at the table below:
| Currency pair | Percentage traded |
|---|---|
| EUR/USD | 27% |
| USD/JPY | 13% |
| USD/GBP | 12% |
| USD/AUD | 6% |
| USD/CHF | 5% |
| USD/CAD | 4% |
| USD/SEK | 2% |
| USD/Other | 19% |
One reason why the USD is so liquid is because the US houses the largest stock exchange in the world, the New York Stock Exchange, where the value of the companies listed amount to over $28 trillion, almost 80 percent of the global stock market.
Also, the US bond market makes up around $31 trillion of the $82 trillion value of the global bond market. During one trading session alone, the dollar could take up over 90 percent of all the currency transactions.
Reserve Currency
The US dollar accounts for over 63% of the world’s currency reserves, meaning that the central banks of many countries hold USD.
The main reason for holding a currency that is deemed to be highly regarded and credible is for trade and borrowing purposes. Another reason a country holds the dollar as a reserve currency is to peg the value of their currency to the USD. An example of a country that does this is China. Other countries maintain a loose peg to the USD.
The advantage of pegging to the dollar is so that these countries can either stabilize their own currencies and therefore their economies and/or to hold the value of their currencies artificially low in order to make their goods more competitive overseas.
Apart from governments (central banks), many non-US based private businesses and individuals hold US dollars primarily for trade reasons. This is especially common in countries where the local currency is not as stable.
In addition to the USD being part of a currency pair, it is also traded against many commodities such as gold, silver, oil, copper, etc. Many major commodities are priced in US dollars, which means that access to US dollars is crucial for anyone in the world who wants to purchase these products.
All of the factors we have mentioned above make the US dollar an important currency and is therefore incredibly important for traders.
Currency Fundamentals
The US dollar is affected by particular economic releases, which can have a large impact on the value of the currency depending on the state of the economy.For example, if there are fears that the US economy may be going into recession, then the market is going to be more sensitive to any economic data, such as non-farm payrolls and consumer spending, which may provide early warning signs that this is the case of a slowing economy.
On the other hand, if the economy is growing and the markets are concerned that inflation may become a problem, then the type of economic news announcements which cause the market to move may be price data releases, such as the CPI (Consumer Price Index) and the PPI (Producer Price Index).
Most Important Economic Indicators to Follow
The economic indicators below are considered by many economists to be the most market moving indicators in regards to the US dollar:
Non-farm Payrolls (NFP)
Shows the change in the number of employed people during the month reported, not including employment in the farming industry.
Retail Sales
The total value of sales at the retail level.It is important because it is a good indicator for the level of consumer spending, which accounts for the majority of overall economic activity in the US.
University of Michigan Consumer Sentiment
A survey conducted on businesses to rate the relative level of current and future economic conditions.
Personal Spending
It measures the change in the inflation-adjusted value of consumer spending.
Consumer Price Index (CPI)
It is the measure of the change in the price of goods and services purchased by consumers, excluding food and energy.
Gross Domestic Product (GDP)
It gives the annualized change in the inflation-adjusted value of all goods and services produced by the US economy.
ISM Manufacturing PMI: a survey of purchasing managers in the manufacturing industry, who are asked to rate the relative level of business
Conditions including employment, production, new orders, prices, supplier deliveries, and inventories.
New Home Sales
The annualized number of new single-family homes sold during the month reported.
Federal Reserve Policy Announcements
Apart from economic data, it is important to also watch the Federal Reserve policy. The Federal Open Market Committee (FOMC) issues a statement after each policy meeting. If it is more hawkish than expected, this is usually good for USD.
For example, if the Fed is expected to raise interest rates, this means that demand for dollar-denominated financial assets (such as US Treasuries) could rise, which would have a positive effect on the USD. On the contrary, if the Fed is expected to cut interest rates, it could lessen demand for dollar-denominated assets and this would have a negative effect on the USD as investors would likely move their funds away from this currency.
Adopting more quantitative easing measures (QE) to stimulate the economy usually tends to weaken the dollar because this measure involves printing more money.
