Homail Azhar
Table of Contents
After reading this article you should be able to tell about United States Economy. What is a USD? How is US monetary policy conducted? What are the Economic Indicators that Affect the USD? What is the Market Dynamics that Affect the USD? What are USD Trading Tactics?
United States of America
The United States of America (USA) is the sole economic and military superpower of the world. The country is made up of 50 states and a federal district called Washington D.C. It is primarily located in North America and also has some territories in the pacific. Since its war and subsequent independence from Britain on 4 July 1776 and the destructive civil war of the 1860s, the US has come to assume the role of a global leader.
Being the world’s top economy, the US plays a major role in global trade and commerce. With a population of more than 331 million people, the US is the third most populous country in the world. It shares a sizable land border with Canada to the north and with Mexico to the south. The US is the founding member of the United Nations (UN), World Bank (WB), International Monetary Fund (IMF), Organization of American States, North Atlantic Treaty Organization (NATO), and other international organizations.
Overview of United States Economy
The United States of America is considered a highly developed country that accounts for a gross domestic product (GDP) of $16.24 trillion, a quarter of global GDP. It is the world’s largest economy by GDP at market exchange rates. As per value, the US is the world’s largest importer and second-largest exporter of goods. Having only 4.2% of the global population, it owns 29.4% of the wealth in the world. The per capita income of its citizens is $51,700, one of the highest in the world. Its main industries include aircraft, automobiles, telecom equipment, transistors, and other industrial materials. Since it is a highly developed country, contrary to popular assumption, its service sector consists of 70% of its GDP output.
Despite being the largest economy in the world, the US runs a significant trade deficit which was $635 billion back in 2010. Canada, China, European Union (EU), Japan, and Mexico remain its major trading partners. From the year 1983 – 2008, the US economy achieved a real compounded annual GDP growth of 3.3%, whereas the weighted average growth rate for G7 countries for the same period was 2.3%. The size of the country’s private sector consisted of 86.4% of the whole economy. The largest private employers are health care and social assistance. It boasts a smaller welfare state and focuses less on the redistribution of wealth compared to other high-income countries of the world. New York Stock Exchange (NYSE) which is the largest capital market in the world is located in the US. Its bond market is also the largest which has a market capitalization of over $31 trillion. Being the largest economy in the world, any internal event affecting the United States will necessarily have repercussions all over the globe.
The United States Monetary and Fiscal Policy
Federal Reserve Systems or Fed is the central bank of the US. It is the main governing body when it comes to deciding and implementing the national monetary policy. The Fed has two main responsibilities which are known as the Fed’s dual mandate is that it must make sure that the prices of consumer goods and services should remain stable and the second one is that it should make sure that there is a sustained economy in the United States. The Fed decides its monetary policy based on these above two objectives and controls the availability and supply of money accordingly. The main thing that separates the Fed from other prominent central banks is that its objectives are based on the longer-term effects of its monetary policy.
The Federal Reserve executes its monetary policy through the Federal Open Market Committee (FOMC). It is a committee within the Fed that is tasked with the responsibility to conduct open market operations by buying and selling US treasury bonds. It also has another task to control the Fed’s Funds Rate, the interest rate that commercial banks charge each other for overnight loans. These loans are taken to ensure that banks have the required reserve. As per law, commercial banks are required to keep these reserves at their local Federal Reserve bank or as plain cash in their vaults.
Fiscal policy, on the other hand, is the exclusive domain of the US government which executes its policy through the US Department of Treasury. At times this department can opt for lowering taxes and allot more resources on infrastructure investments like highways, expressways, schools, broadband, etc. If the economy takes a turn and inflationary pressure goes out of hand then it can decide to go for raising taxes and cutting spending.
United States Dollar (USD)
United States Dollar or USD is the legal tender of the United States of America and its territories. This currency was introduced with the passage of the Coinage Act of 1792. It is also called greenback due to its historical green color. The Federal Reserve is tasked with issuing and controlling the circulation of the USD. Due to its dominance in global trade and commerce, the USD takes up a share of 86% in world currency reserves. This is what makes this particular currency the most liquid currency in the world. Another way of seeing it is that NYSE, the largest capital market in the world has companies listed whose total value equals $28.5 trillion, near about 78% of the global capital market. The US has a bond market of $31.2 trillion out of the $82.2 trillion global markets. So every single transaction that is being conducted throughout the globe involves USD in some way.
Both the Fed and the US government believe that the entire effort should go towards keeping the USD strong which will benefit the US economy and also the rest of the world. Another reason for the dollar’s strength is that most international transactions involve USD so, the dollar is always in high demand. An important aspect of global monetary policy is that central banks can print as much money as they can but they must keep a similar quantity of USD in reserves. If for any reason, the dollar has a steep fall then it would have wide-ranging implications as all the other countries on earth have their currencies pegged to the dollar.
Important Economic Indicators Affecting the USD
There are some most important economic indicators which affect the US economic growth and subsequently the value of the USD. Those are Non-Farm Payroll, the employment report, GDP, Retail Sales report which measures the monthly change in the total value of sales at the retail level, Consumer Price Index (CPI) which measures the change in prices of a fixed basket of goods and services, Personal Consumption Expenditure which measures the change in prices for the consumer goods, University of Michigan Consumer Sentiment which releases its consumer sentiment report. These indicators show a general trend going on in the American economy.
Market Dynamics that Moves the USD
There are many market dynamics that affect the value of the United States dollar. Some of those events are related to the US only, some are global. First of when USD is perceived at risk of losing its value then traders and investors as a whole flock to the safe-haven investment in gold. As a result the price of gold increases. So prices of gold are inversely correlated to the value of USD. So when the prospect for the US economy and subsequently USD looks bright then the gold prices decline as people go for buying USD and selling gold.
Developments of United States Economy have major implications for the value of the USD. When positive news like high employment figures comes out then people start purchasing the US dollar. On the other hand, negative news like reduced retail sales data makes people flock from the USD to safe-havens.
Economic developments all around the world also affect the value of the USD. Any positive economic news like a good GDP figure from Australia or from New Zealand affects its value. Here bond yield differential also plays a major role. Since people always look for a good deal for their money, if a particular country’s bond is offering a high-interest rate then people will start purchasing those and as a result, USD will lose in value.
Interest rate grapevine is another good factor. The market gets involved in speculation about the upcoming news about the interest rates. People look to the meeting of the FOMC and other stalwarts of the US financial sector to gauge any scoop about the prospective interest rate. If interest is expected to go up then investors will start investing in the US economy for higher returns and vice versa.
USD Trading Tactics
A good tactic is very crucial for sound investment and USD is no different than that. First of all, as a trader, you will have to look for the difference between the economic developments in the US and developments in other countries. For example, if US retail sales figures are robust and UK employment figures are not good then it is a good reason for going short for GBP/USD.
The US Dollar Index (USDX), which calculates the exchange value of the USD in relation to a fixed basket of other major currencies, is also a fine measure of the strength of the USD. If you keep a tab of the USDX then you can get important clues about where USD is heading. An upward trending USDX is an additional confirmation that you should go short for EUR/USD.
Last of all, any hawkish remark from the Fed will mean going long on the USD/JPY while dovish comments would hint at going short.
