USD explained: A guide to the US dollar
Ben Lobel May 25, 2021 11:42 AM
The US dollar is the world’s reserve currency and the currency of the world’s largest economy, making it a powerhouse in the forex market. Discover everything you should know about USD before you open a position.
Introduction to the US dollar
The US dollar is the national currency and legal tender of the United States, the largest economy in the world. It is also regarded as the world’s reserve currency, meaning it is held in large quantities by international central banks. Additionally, USD is used as official currency by a range of other sovereign nations worldwide, for example Ecuador and Zimbabwe.
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Economy of the US
As the largest global economy, the US has a GDP of more than $21 trillion, according to 2019 World Bank statistics. This compares to some $14 trillion for the second-largest economy, China.
The Federal Reserve is the country’s central bank, which is responsible for overseeing monetary policy and maintaining financial stability.
The economic history of the US documents a journey from 17th century colonial times of subsistence farming, building to a market economy based on the trade of natural resources and agricultural products. As transport infrastructure developed, international trade began to expand, and the likes of farming, fishing, and shipbuilding gained more market potential.
Post independence in 1776, the industrial revolution brought cotton weaving, and railroad and canal developments bolstered infrastructure and enabled trade routes. The development of industry following the civil war powered continued growth into the 20th century with mass production and the onset of regulations and private enterprise.
Today, the country boasts formidable performance in sectors such as technology, healthcare, retail and construction, with some of the world’s leading firms by market cap and innovative capacity.
What moves the price of the US dollar?
There are a variety of factors that influence the price of USD against other currencies. These include monetary policy decisions from the Federal Reserve, macroeconomic releases, and political events, but also cover oil prices and balance of payments (export and import values).
Traders should be aware of Fed meeting dates and the release dates of key reports to help them keep on top of developments. Check out our economic calendar and don’t miss the latest announcements that can move markets.
It’s important to note that while USD may be strengthening or weakening, you still have to consider how the other currency in the pair is performing before assessing the reasons for a pair’s moves.
The Federal Reserve controls monetary policy and will raise interest rates to control inflation. Higher rates tend to stimulate foreign investment, meaning the demand for that particular currency is greater. In turn, this means USD is likely to strengthen against a basket of other currencies.
Conversely, interest rates can be lowered in an attempt to stimulate economic growth. However, this may lead to investors seeking currencies with a better return, pushing the USD price down.
News reports to look out for when trading USD include sentiment, which shows whether traders are net long or short, inflation data, consumer confidence, which can be a benchmark for the direction of the economy, and GDP itself, the definitive measure of economic activity.
A rising GDP also tends to mean a strengthening currency, and a falling GDP a weakening currency. Other measures of how the economy is doing can be found in retail sales, and services and manufacturing PMIs.
Political and socioeconomic influences can both hit currency prices hard. For example, the lead-up to the 2020 US election result saw USD sink against other currencies as vote counting dragged on.
When coronavirus hit global economies in late February 2020, USD initially plunged as traders expected a Fed rate cut to mitigate the effect of the pandemic. However, despite said cuts ensuing, the dollar then surged to new heights as the greenback became the safe haven of choice amid the enduring economic instability.
A brief history of the US dollar
The history of the US dollar goes back to the Mint Act of 1792, some 16 years after the nation achieved independence. At that time, the dollar became the principle currency and coins were established in 1793 at the Philadelphia Mint. Prior to this, British colonial rule saw Pounds, shillings and pence widely used in varying denominations from colony to colony.
It wasn’t until 68 years later that paper money was established as demand notes to fund the Civil War of 1861. These notes were often referred to as greenbacks, and still are today. These United States Notes, as they were known, were first published in 1862, and a standard system for printing the notes was first developed in 1869.
The Gold Standard was introduced in 1900, making gold and silver legal-tender US coinage. However, this system was suspended in 1933, and in 1971, President Richard Nixon announced that the US dollars would no longer be converted to gold at a fixed value.
Popular dollar currency pairs
EUR/USD is the forex ticker for the exchange rate between the Euro and the US dollar. It tells traders how many US dollars are needed to buy one Euro in real time.
The pair is the most traded in the world, making up around 24% of all currency trades, as of 2019 figures from the Bank for International Settlements. The pair’s popularity means consistently high liquidity and tight spreads.
Encompassing the Eurozone and the US economies, traders will need to consider fundamental factors surrounding the European Central Bank, such as ECB interest rate decisions, as well as those US releases capable of moving price. Due to its high trading volume, EUR/USD isn’t generally known for high volatility, meaning it may be less susceptible to sudden and large price shifts.
USD/JPY is the forex ticker for the exchange rate between the US dollar and the Japanese Yen. It tells traders how many Japanese Yen are needed to buy one US dollar in real time.
The pair is the second most-traded in the world, making up around 13.2% of all currency trades, as of 2019 figures from the Bank for International Settlements. As USD is the most traded currency and JPY sees heavy volume in Asia, the pair’s high liquidity and tight spreads are consistent.
GBP/USD is the forex ticker for the exchange rate between the British Pound and US dollar – the pair is also known as Cable. It tells traders how many US dollars are needed to buy one Pound in real time.
Cable is consistently in the top five most traded currency pairs globally, and as of latest stats it is the third-most-traded – representing approximately 11% of all forex trades by volume.
When trading Cable, market practitioners should be aware that GBP/USD tends to rise in times of UK inflation being consistently lower than that of the US. Cable also frequently rises when UK interest rates rise more than those of the US. This could happen, for example, when the BOE raises rates and the Federal Reserve does not.
US Dollar Index
The US dollar Index is a useful measure of how USD is doing relative to a basket of other currencies. Find out more about the USDX.
Dollar trading hours
The US dollar is available to trade 24 hours a day, five days a week – from 5pm (EST) on Sunday evening to 4pm Friday night.
The best time of day to trade USD will depend on which pairing you decide to focus on. As a rule, each pair will see the most movement when its sessions overlap. For example, the USD/JPY pair would be more highly traded when both the New York and Tokyo forex sessions overlap.
Start trading dollar pairs
You can trade the US dollar against other major currencies such as the Euro, British Pound and Japanese Yen, as well as 80+ other pairs, via CFDs. Take your position on whether forex prices will rise or fall in the future, without having to buy the underlying asset.
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