Upside risks to inflation have receded

Monetary policy in the US is shaped by the Federal Reserve (Fed). The Fed has two mandates: to ensure price stability and to promote full employment. Its main tool for achieving these objectives is the adjustment of interest rates. When prices rise too quickly and inflation is above the Fed’s 2 percent target, it raises interest rates, raising borrowing costs throughout the economy. This results in a stronger US dollar (USD) as it makes the US a more attractive place for international investors to park their money. When inflation falls below 2% or the unemployment rate is too high, the Fed can lower interest rates to encourage borrowing, which hurts the greenback.

The Federal Reserve (Fed) holds eight policy meetings a year, where the Federal Open Market Committee (FOMC) assesses economic conditions and makes monetary policy decisions. Twelve Fed officials attend the FOMC—the seven members of the Board of Governors, the president of the Federal Reserve Bank of New York, and four of the remaining eleven regional Reserve Bank presidents, who serve rotating one-year terms. .

In extreme situations, the Federal Reserve can resort to a policy called Quantitative Easing (QE). QE is the process by which the Fed substantially increases the flow of credit in a stuck financial system. It is a non-standard policy measure used during crises or when inflation is extremely low. It was the Fed’s weapon of choice during the Great Financial Crisis of 2008. It involves the Fed printing more dollars and using them to buy higher quality bonds from financial institutions. QE usually weakens the US dollar.

Quantitative tightening (QT) is the reverse process of QE, whereby the Federal Reserve stops buying bonds from financial institutions and does not reinvest the principal of bonds it holds at maturity to buy new bonds. It is usually positive for the value of the US dollar.