Dollar may break higher as Fed turns hawkish amid inflation fears

The US dollar, which has spent months trading in a narrow range, could be poised for a stronger move higher as investors increasingly expect the Federal Reserve to focus on rising inflation risks rather than interest rate cuts.

The dollar had weakened sharply in the first half of last year, falling nearly 11%.

Since then, however, the currency has remained largely rangebound, frustrating investors looking for either a deeper decline or a sustained recovery.

Market participants are closely watching the direction of the dollar because of its central role in global finance and trade.

A weaker dollar tends to benefit US exporters by increasing the value of overseas earnings when converted back into dollars.

It also improves returns for US investors holding international assets.

On the other hand, a stronger dollar can reduce the attractiveness of foreign investments once gains are converted back into the US currency.

It can also make imported goods cheaper for American buyers, unless tariffs offset those benefits.

Fed expectations lift dollar sentiment

Investors said growing concerns over inflation and rising Treasury yields have improved the dollar’s near-term outlook.

The dollar index, which tracks the US currency against six major peers, has gained nearly 1.5% since February 27, the day before the US-Israeli strikes on Iran.

The index was last trading at 99.13, slightly below the 101 level that has capped the currency’s trading range for roughly a year.

Investors noted that the selloff in US Treasuries has pushed yields higher, increasing the dollar’s appeal.

Concerns that higher oil prices caused by the Iran conflict could fuel inflation have also supported the currency.

Although Treasury yields have eased somewhat in recent sessions due to hopes of progress on reopening the Strait of Hormuz, they remain significantly above pre-conflict levels.

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.

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 Treasury yield, which closely reflects expectations for Federal Reserve policy and is heavily monitored by currency traders, 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 investors said the dollar continues to benefit because global oil and gas trade is primarily conducted in the US currency.

In addition, 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

Investors are also closely monitoring the Federal Reserve’s next steps.

Fed Chair Kevin Warsh had previously been expected to support rate cuts, but rising inflation expectations have reduced the likelihood of easier monetary policy.

Despite the stronger outlook for the dollar, investors said the Iran conflict remains the biggest uncertainty for markets.

A lasting resolution to the crisis could weaken the dollar by easing inflation concerns and reducing demand for safe-haven assets.