US dollar climbs to 2-month high on hawkish Fed expectations

The US dollar index climbed to 101.24 on Tuesday, marking its highest level in nearly two months, as stronger-than-expected manufacturing and services data reinforced expectations that the Federal Reserve will extend its hawkish monetary policy stance. The US manufacturing Purchasing Managers' Index reached a 52-month high of 57 while the services index hit a 59-month peak at 58.7, according to data released this week.

Investors have sought refuge in cash assets amid ongoing geopolitical tensions in the Middle East, contributing to the greenback's appeal as a safe-haven currency. The shift away from risk assets has compounded the dollar's strength alongside the robust economic indicators.

Fed tightening bets surge

Money markets are currently pricing in a 70% probability that the Federal Reserve will implement a 25-basis-point rate hike next month, reflecting persistent inflationary pressures and economic resilience. The shift in expectations accelerated after Federal Reserve Board member Michael Barr suggested that additional tightening might be necessary to combat sustained price pressures.

Jane Foley, senior foreign exchange strategist at Rabobank, told Anadolu that the robust PMI readings demonstrated economic vitality that could concern Fed hawks. "The impact of the data was magnified by yesterday's rise in oil prices and remarks from the Fed's (board member Michael) Barr that more rate rises might be needed — together these factors helped accelerate market forecasts for another Fed policy tightening as soon as next month which underpinned with value of the US dollar," she said.

Analysts warn of stretched rally

Kyle Chapman, a foreign exchange markets analyst at the London-based Ballinger Group, told Anadolu that the dollar appreciated due to the Fed's shift towards a more hawkish stance, weak risk appetite, and ongoing strength in oil prices. "US rates have risen across the curve after Warsh reaffirmed his commitment to monetary policy discipline," he said.

Francesco Pesole from the ING Group stated that strong US PMI data, rising oil prices, and weak risk appetite contributed to the US dollar's rise, while the currency's move has started to look "stretched relative to fundamentals." "We are cautious in calling for a bottom in the dollar just yet because any upside surprise in upcoming US data releases can easily prompt markets to fully price in an October Fed hike and prop up short-term rates even more, but if this risk doesn't materialize, we expect a correction in DXY (US Dollar Index) in the coming weeks, with a return to the 100-100.5 area," he said. Pesole added that "USD/JPY remains another source of potential downside risk for the dollar — the rapid rally in the pair may draw Japanese authorities to intervene that could easily spill over into a weaker USD across the board."