U.S. dollar rallies as market anticipates higher interest rates

The U.S. dollar rallied on Sunday, trading close to a seven-week high as the market anticipated the Federal Reserve to hike the interest rates higher and for a longer period.

The dollar index (DXY), which tracks the currency against six other major currencies, was at 105.17, only slightly below the seven-week high of 105.32 it hit on Friday. The index is on track to snap its four-month losing streak and gain three percent this month.

The euro rose slightly by 0.08 percent to $1.0554 after hitting a seven-week low last week. Meanwhile, the sterling traded at $1.1959, going up by 0.13 percent during the day.

Japan’s yen strengthened by 0.15 percent to 136.26 per dollar. Earlier in the session, the currency slid to over a two-month low of 136.58. The yen traded lower in recent days as the Bank of Japan signaled that it would maintain a dovish monetary policy, even with a new governor.

The Australian dollar rose by 0.12 percent to $0.673, while the New Zealand dollar rose by 0.13 percent to $0.617 against the greenback.

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As the market expected the U.S. central bank to further tighten its rate policy, investors began to place their funds in the dollar for its lower investment risk. The market now expects the Fed to hike the interest rates up to 5.42 percent, meaning there will be several more hikes in the coming months.

Previously, the market also projected that the Fed would cut interest rates by late 2023. However, the market is now less optimistic about the central bank cutting interest rates within the year. Lotfi Karoui, an investment strategist at Goldman Sachs, explained that the Fed still needed to balance the U.S. job market before considering a policy pivot.

The job report revealed that the U.S. had added 517,000 payrolls in January, significantly above economists’ estimates. Meanwhile, the U.S. gross domestic product grew by 2.9 percent in the fourth quarter of 2022, also beating earlier forecasts.

Last Friday, the government published the personal consumption expenditures price index — which analysts said to be the Fed’s preferred inflation indicator because it offers broader coverage of the economy. The index showed an increase of 0.6 percent in January after rising by only 0.2 percent in December.

Meanwhile, consumer spending, which represents more than two-thirds of economic activity in the U.S., surged by 1.8 percent last month. Analysts had earlier predicted that the index would increase by 1.3 percent.

National Australia Bank senior currency strategist Rodrigo Catril said the new data showed the U.S. economy had a “stronger position than many of us had expected” at the beginning of the year, increasing the urgency for further monetary tightening by the Fed.

Upcoming rate hike

The Federal Open Market Committee (FOMC) will hold a rate-setting meeting on March 21 to 22. The market expects another 25-basis-point rate hike in the meeting, although few analysts suggest that a 50-basis-point hike is possible if inflation remains high.

“We now believe it is a much closer call that officials hike by 50 basis points in March than our earlier 25 basis points assumption,” Kevin Cummins, chief economist at NatWest Markets, said.

“We put the odds at about 60 percent that the FOMC hikes by 50 bps.”

Kevin Cummins, Chief Economist at NatWest Markets

The two-year Treasury bond yield, which usually moves according to interest rate expectations, rose to 4.809, only slightly lower than the three-month high of 4.840 percent last week. The yield curve between two-year and 10-year Treasury notes remained inverted at 87.7 basis points, indicating the market’s expectation of a recession.