Currency traders, businesses, and governments are concerned about the exchange rate and value of their country’s currency and foreign currencies that impact the economy.
For example, if you trade forex on the TradingView login, you should regularly check the strength of the US dollar and other major currencies. But why so?
What makes the USD so strong? And how does it impact the way traders buy, sell, and exchange currencies on the global forex market? Explore these answers in this article.
The US Dollar
The US dollar (USD) is the official currency of the United States of America. It is the most popular currency in the world based on trading volume, sentiment, and economic valuation.
The USD is denominated in $1, $2, $5, $10, $20, $50, and $100 bills. The US Federal Reserve no longer issues $500, $1,000, $5,000, and $10,000 bills, but they are still legal tender and may still be in circulation.
Over 66 countries have their currencies pegged to the USD, with 11 countries officially using the USD as a legal tender.
The USD is also the most-traded currency in the global currency market, having about 85% of the daily transaction volume (worth over $5 trillion).
The Strength of the USD
The USD strength is measured using an index that compares it against eight other strong currencies, such as the GBP and euro.
The USD index (DXY) rises if the strength of the USD increases and falls when the strength reduces. The index effectively measures the strength of the USD and is often analyzed by currency traders to predict prices.
This is why news events and technical information affect the price of the USD index. The DXY currency trades at 104.3284.
Why the USD is So Strong
There are several reasons for the USD’s strength and economic importance today.
The USD has a long history but has spent a relatively shorter time as the world’s strongest currency going by the new monetary standard adopted after the Gold System crashed.
Here are the most important factors impacting the strength of the USD:
The Biggest World Reserve Currency
A reserve currency is a currency that is held in large quantities by central banks around the world.
Currently, the USD has 60.75% of the global currency reserve, with China having the biggest reserve.
The USD has now served as the biggest reserve currency for 90 years, gradually nearing the 100-year approximate “tenure” that reserve currencies serve.
The USD’s status as the biggest reserve currency contributes massively to its strength, making for the high demand for the currency.
It also allows the US to borrow at lower costs and make around $100 billion yearly.
Demand and Supply
The demand and supply of the USD are determined by several factors, ranging from market sentiments to employment data and trading deficits/surpluses.
Such factors are typically categorized as technical or fundamental data. Others are speculation, payroll data, public debt, GDP data, and other economic information.
The strength and demand of a currency are directly related, impacting the other. Thus the stronger the USD, the more the demand, and the more the demand, the stronger the currency.
The US Economy
As one of the biggest economies in the world, the US boasts robust economic conditions that enable local and international businesses to thrive.
Although the US imports goods and services, there’s a near balance with local production that allows it to maintain a healthy economy.
With features such as being the second-largest country by purchasing power parity, eighth-highest per capita GDP, and third-largest manufacturing country.
Government laws and financial policies also encourage businesses, with interventions to stimulate the economy.
The US attracts top global talent across its industries, invests in research, and has the most billionaires. A strong economy backing it contributes massively to the USD’s strength.
Increased Interest Rates
As global inflation triggers economic conditions, the US Reserve bank hikes interest rates to keep inflation at optimal levels. Hiking interest rates increase a currency’s strength by increasing its market demand.
Investors and traders are always watching for factors that will strengthen the currency, and when the interest rate is increased, it typically triggers bullish traders to take up buying positions.
The increased demand pushes the market value upward and ensures more investors hold the USD for profit.
This also encourages businesses that typically benefit from increased USD prices. Although this works, the interest rate is typically adjusted to maintain a 2% inflation rate, a healthy rate for the US economy.
Closely linked to the robust economy is the political stability that the US enjoys.
A stable internal government and numerous foreign treaties, alliances, and trade agreements give the US a strong political advantage for a strong currency.
The advanced US military is also a major factor in its political stability. Today, the US ranks as one of the best countries to do business and among the top destinations for various activities.
Trading the USD
The USD is a major currency, forming one part of all major currency pairs in the forex market. Trading the USD requires extensive technical and fundamental data analysis to find the best trading opportunities.
As a trader, you must monitor the USD’s strength compared to the currencies you are trading. This helps you to spot trading opportunities and plan your trades.
You can use the technical tools provided on your broker’s platform to analyze the USD.