Previous article
Dollar heads for best month since june amid hawkish Fed rhetoric
Economy
The dollar is wrapping up its best month since June, as the Federal Reserve’s renewed focus on combating inflation has driven up interest rate expectations and US bond yields.
The Bloomberg Dollar Spot Index rose 1.9% in September, reaching a two-month high. The currency is being supported by strong US economic data and elevated inflation risks. Conflict in the Middle East is keeping energy prices high and has pushed Treasury yields to historic peaks; the yield on 30-year bonds hit its highest level since 2002.
Markets are currently pricing in nearly a full percentage point of Fed rate hikes over the next 12 months, further strengthening the dollar.
"The dollar remains driven by US data," noted Jayayati Bharadwaj, Head of FX Strategy at TD Securities. "Surprises in US statistics are setting the direction for the dollar in the short term, as is the question of whether the Fed can raise rates by roughly the amount the market is pricing in."
The rally, which began following the Fed's first rate hike in three years, continues to be fueled by hawkish statements from central bank officials. On Tuesday, Fed Governor Michael Barr reiterated the warning that further rate hikes would likely be needed to slow inflation. New York Fed President John Williams also stated that another hike "might be appropriate later this year to bring inflation back to the target level in a timely manner." A widening interest rate differential and robust US economic growth are forcing dollar bears to rethink their positions. Morgan Stanley recently abandoned its long-held forecast that the dollar would weaken in the second half of 2026.
Traders are closely watching Friday’s September employment report, which will test bets on aggressive monetary policy tightening. Additionally, the US Personal Consumption Expenditures (PCE) price index for August—the Federal Reserve’s preferred inflation gauge—is due out on Wednesday.
Inflation risks are elevated globally, yet not all economies are prepared to withstand more aggressive rate hikes. The dollar's outlook against other currencies is driven by expectations regarding the divergence in interest rate trajectories.
In September, all G10 currencies except the yen weakened against the dollar. The yen has been supported by growing risks of currency intervention by Japanese authorities and expectations of further rate hikes by the Bank of Japan.
However, some indicators suggest the dollar rally may be running out of steam. A dollar momentum indicator rose above 70 on Tuesday, potentially signaling overbought conditions. Bloomberg’s Relative Strength Index (RSI) for the dollar entered overbought territory as early as September 24.
"We think the dollar is starting to look overheated," said Noah Buffam, a strategist at CIBC Capital Markets.
Kamakshya Trivedi, global head of FX and interest rate strategy at Goldman Sachs Group, expects the dollar to trade within its current range. He forecasts that the Federal Reserve will raise rates only one more time, in October.