U.S. dollar hits two-month high as risk appetite wanes

The U.S. dollar reached a two-month high in the forex market on Tuesday due to investors' declining risk appetite amid uncertainty surrounding the country's debt ceiling issue.

The dollar index, which keeps tabs on the currency's value against six major peers, hit 103.65 or its highest level since March 20. Against the Japanese yen, the greenback hit the highest rate in nearly six months at 138.91 earlier in the session.

Monex USA vice president of trading and dealing John Doyle said the lack of progress in the U.S. debt ceiling kept the market "nervous" even though most investors agreed that lawmakers would come to an agreement before the federal government saw a "catastrophic" default.

"I think the dollar saw a modest boost today as stocks have declined, mostly due to the lack of progress on the debt ceiling deal."

John Doyle, trading and dealing vice president at Monex USA

Debt ceiling talks between representatives of President Joe Biden and Republicans on Tuesday ended without a deal as the deadline to raise the nation's $31.4 trillion debt limit approached. Sources said the two sides could not agree on federal spending cuts.

Democrats have said they agree to freeze public expenditures at the current rate, but House Republicans demanded to bring down spending to the same level in 2021, reversing increases in the intervening years.

Rep. Garret Graves, who participated in Tuesday's discussion, said forming a deal would be difficult if the White House did not acknowledge its "spending crisis." Democrats previously proposed new tax mechanisms to boost tax revenues and resolve the ongoing debt crisis.

Economists warned that the U.S. could default on its debt obligations by the beginning of next month, with them comparing the current situation with a similar crisis in 2011 in which the U.S. raised the debt limit 72 hours before the deadline.

According to analysts, a default will push the U.S. economy into a recession and negatively affect other nations. Moody's Analytics chief economist Mark Zandi said "no corner of the global economy will be spared" if the first-ever U.S. default happened.

Hawkish remarks from Fed officials

Analysts said the hawkish comments from several voting members of the Federal Reserve regarding further interest rate hikes also supported the dollar in forex trading. Minneapolis Fed President Neel Kashkari said it was "a close call either way," noting that a pause in the next policy meeting would not necessarily indicate an end to the monetary tightening cycle.

Last week, St. Louis Fed President James Bullard said he considered further interest rate hikes as an "insurance" policy against inflation. According to Bullard, he will keep an "open mind" going into the Federal Open Market Committee meeting in June.

Fed Chairman Jerome Powell, on the other hand, said on Friday that it was still unclear whether the benchmark rate would need further increases. He pointed out that officials are still assessing the impact of previous hikes on borrowing costs and the recent decline in credit availability.

"We're probably looking at a market that is repositioning itself for a little bit more dollar strength here as these Fed rate cut bets get pushed back a little bit further and higher for longer," said Edward Moya, senior market analyst at brokerage firm OANDA.

Fed fund futures predicted a 30 percent chance for a rate hike next in the upcoming meeting, higher than the 20 chance forecast after the central bank's policy meeting earlier this month. Investors also predicted that the Fed funds rate would range around 4.75 percent by the end of this year. Currently, the benchmark rate ranges between 5.00 to 5.25 percent.

The market is currently anticipating the Fed's minutes from its previous meeting to provide guidance for the central bank's future policy, which is due on Wednesday.