Dollar near two-week high as oil surge lifts yields, Fed hike bets

The dollar inched up to trade near a two-week high on Tuesday as surging oil prices lifted Treasury yields and reinforced expectations that the Federal Reserve will raise interest rates this week.

It also gained support as risk appetite weakened after stock markets tumbled, with AI-related shares under pressure after industry leaders called for slower development to contain potential threats to humanity.

Markets now see a Fed hike on Wednesday as a near certainty, with CME’s FedWatch tool pricing in a roughly 93% chance of an interest-rate increase, which would be the first in more than three years.

“The combination of higher oil, higher US yields and weaker risk appetite helped lift the US dollar broadly,” Christopher Wong, FX analyst at OCBC, said in a note.

Near-term support may persist, but with a hike now heavily priced in, further dollar upside will likely require the Fed to keep the door open to additional tightening, he added.

The dollar index, which measures the greenback against a basket of currencies, was last at 99.55.

The euro was slightly weaker against the dollar at US$1.1538, as was sterling at US$1.3494.

The yen also pulled away from a seven-month high, last down roughly 0.2% at 154.72 ahead of an expected Bank of Japan rate hike on Friday.

Rate hikes awaited

Oil prices climbed to US$107 a barrel, hovering near a four-month peak, after Yemen’s Iran-aligned Houthis attacked Saudi Arabia and Gulf-Iran talks were postponed.

That added to inflation worries and drove benchmark 10-year Treasury yields to breach the key psychological level of 5% for the first time since October 2023 in the previous session. The yield last traded at 4.9895%.

Those inflation pressures follow a much stronger than expected jobs report and a pickup in consumer prices for August, strengthening market conviction that the Fed will raise rates on Wednesday.

Economists polled by Reuters also expect at least one more hike by the end of March, reversing a fragile no-change consensus that prevailed before official data on Friday showed firm inflation.

The inflation outlook now hinges on oil prices, but the broader macro picture does not warrant more hikes than currently priced in the curve, analysts at BCA said in a note.

“Limited hawkishness from here argues for curve steepeners and limited USD upside.”

Markets are also all but certain that the Bank of Japan will raise rates on Friday. Market sentiment on the yen is starting to shift, with speculators turning to a net long position on the Japanese currency for the first time since February.

Elsewhere, the New Zealand dollar and the Australian dollar were both roughly 0.1% lower, last at US$0.5769 and US$0.7133, respectively.

Offshore yuan was flat at 6.708 per dollar, hovering near its strongest level in more than three years, as markets await industrial output and retail sales data later in the day.

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