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The U.S. Dollar (USD) ranks as the most popular currency in the world, trailed by the Euro (EUR), Japanese Yen (JPY) and British Pound Sterling (GBP).

So, what is the drive to make the US Dollar become popular ?

Federal Reserve monetary policy

The central bank uses open market operations and other monetary policy levers to provide liquidity as needed. If economic growth is strong, inflationary pressure rises, and the Fed is likely to attempt to cool activity by raising interest rates. Conversely, if there is a downturn, disinflationary pressure is likely to push the Fed to lower rates as a way to spur a pickup in economic growth.

The U.S. central bank also holds press conferences where markets can approximate the direction of interest rate hikes or cuts based on hawkish or dovish rhetoric from Fed officials.

Unexpectedly positive or negative data from these various indices has a tendency to lead markets to speculate on potential hawkish or dovish shifts in the policy path. The readjustment of portfolios to account for such changes translates into US Dollar exchange rate fluctuations.

Market sentiment

Over 80% of all global monetary transactions are settled in the greenback, according to data from the Bank of International Settlements. That makes it by far the most liquid of the major currencies.

What this means in practice is that it can absorb large in- and outflows of capital with relatively less volatility than alternatives. That often makes it a natural choice for traders looking to “cash out” of their investments at times of market stress when focus shifts from prioritizing returns to capital preservation.

This has frequently produced an inverse relationship between the US Dollar and assets anchored to a positive market sentiment – such as stocks, commodities and high-yielding currencies – at times of market stress.

Gold and the US dollar have an inverse relationship

Gold and the U.S. dollar were associated when the gold standard was being used. Even though the gold standard is gone, there’s still a psychological tilt towards gold whenever the value of the U.S. dollar decreases. The inverse relationship remains because:

Ø A falling dollar increases the value of other countries’ currencies. This increases the demand for commodities including gold. It also increases the prices.

Ø When the U.S. dollar starts to lose its value, investors look for alternative investment sources to store value. Gold is an alternative.