The US dollar, which has traded in a narrow range for months, may be on the verge of a decisive breakout as investors increasingly expect the Federal Reserve to prioritize inflation risks over rate cuts. The currency weakened sharply in the first half of last year, falling nearly 11%, but has since remained rangebound, frustrating traders looking for a clear direction.
Fed Expectations Lift Dollar Sentiment
Growing concerns over inflation and rising Treasury yields have improved the dollar's near-term outlook. The dollar index, which tracks the greenback against six major peers, has gained nearly 1.5% since February 27, the day before US-Israeli strikes on Iran. The index was last trading at 99.13, just below the 101 level that has capped its trading range for roughly a year.
The selloff in US Treasuries has pushed yields higher, increasing the dollar's appeal. Higher oil prices caused by the Iran conflict have also fueled inflation fears, supporting the currency. Although Treasury yields have eased somewhat due to hopes of progress on reopening the Strait of Hormuz, they remain significantly above pre-conflict levels.
Treasury Yields Strengthen the Dollar's Appeal
The benchmark 10-year US Treasury yield has climbed roughly 50 basis points since the Iran war began in late February. The 2-year yield, which closely reflects expectations for Fed policy, has increased nearly 70 basis points. Higher yields typically make the dollar more attractive to global investors seeking better returns.
Bond yields in Europe and Asia have also risen, but the dollar continues to benefit because global oil and gas trade is primarily conducted in US currency. Additionally, the US economy has shown greater resilience to the energy shock than several major economies, particularly in Europe. Even investors who remain bearish on the dollar over the long term have softened their stance in the short term.
Inflation Fears Remain in Focus
A major driver behind the rise in Treasury yields has been growing inflation expectations linked to higher oil prices. Rising inflation reduces the attractiveness of fixed-income assets, prompting investors to demand higher yields. Recent economic data have reinforced concerns that inflation pressures are not easing as quickly as markets expected.
Market-based measures of long-term inflation expectations, known as break-evens, climbed to a three-year high of 2.508% on the benchmark 10-year note earlier this month before easing slightly to around 2.4%. The Iran conflict remains the biggest risk, and a lasting resolution could weaken the dollar by easing inflation concerns and reducing demand for safe-haven assets.
Meanwhile, US equities continued to rally. The S&P 500 rose around 0.6%, while the Nasdaq gained about 1.2%, with both indexes ending at record highs. For more on related market moves, see Sterling Slips to Near Two-Month Low as Dollar Strengthens on Rate Bets and Middle East Unrest and Silver Tumbles to Two-Month Low as Rising Yields, Hawkish Fed Bets Weigh.
This article is for informational purposes only and does not constitute financial advice.
