The US dollar index (DXY) hit new highs on Tuesday in line with rising expectations for multiple 50 bp rate hikes by the Federal Reserve to curb inflationary pressures. Meanwhile, US Treasury yields are approaching 3% for the first time in three years as markets price in a faster tightening bias.
The DXY broke the 101 mark on Monday, the highest since March 2020, currently trading near 100.9 levels. Future markets are now pricing in a 96% chance of a 50 bp hike at May’s meeting. Similar moves are expected before year end, bringing the accumulative hikes of 250 bp in total. A scenario that supports the bullish sentiment for the greenback during 2022.
US annual inflation rate accelerated to 8.5% in March, the highest since 1981. Energy was the biggest contributor and is expected to remain so given the recent spikes. Core inflation, excluding energy and food volatile prices, also spiked to its highest in 40 years. Inflation was seen peaking in March, but given the strong demand, supply constraints and geopolitical tensions, inflation will likely remain elevated for longer than previously anticipated.
The US dollar climbed to a fresh 20-year high against the Japanese Yen by trading above the 129.00 handle as the diverging monetary policies continue to widen the spread between Japanese and US bond yields. The Yen failed to maintain its rally after Bank of Japan Governor Haruhiko Kuroda and Finance Minister Shunichi Suzuki expressed their concerns about the weakening currency. Comments were apparently overlooked by the market, keeping the Yen under selling pressures pushing the USD/JPY pair up by almost 200 pips.
On Monday, St. Louis Fed President James Bullard said that inflation is “far too high for comfort” and reaffirmed his case for raising rates to 3.5% by the end of the year.
The single currency depreciated to 1.07 against the US dollar for the first time in almost two years amid persistent uncertainty about the timing of rising interest rates in the Eurozone. Investors will be watching comments from Fed chair Jerome Powell and ECB’s President Christine Lagarde on Thursday for more clarity about potential policy paths.
FOMC members voted to increase the fed funds rate by 25bp in its March meeting and officials are expecting additional six hikes this year to peak at 2.8% in 2023. Fed members noted the economic uncertainty in the wake of rising geopolitical tensions. However, that is not expected to hinder shrinking the Fed balance this summer.
The committee mentioned that both economic activity and employment indicators have continued to strengthen while inflation remained elevated reflecting supply and demand imbalances related to the pandemic, higher energy prices, and broader price pressures. Despite the uncertainty around the economy, the board noted that recent events are likely to create additional upward pressure on inflation and weigh on economic activity. In this regard, the committee is prepared to do whatever it takes to keep inflation under control. This opens the door for an aggressive series of rate hikes before year end.
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