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

The U.S. dollar inched higher, nearing a two-week peak on Tuesday, as soaring oil prices boosted Treasury yields and heightened the likelihood of a Federal Reserve interest rate hike this week. The greenback also benefited from weakened risk appetite following steep declines in stock markets, particularly in AI-related shares, as industry leaders called for a more cautious approach to development to mitigate potential existential threats to humanity.

Market analysts now consider a rate increase on Wednesday to be almost certain, with the CME's FedWatch tool pricing the probability at around 93%. This would mark the first rate hike in over three years. The surge in oil prices, which rose to $107 a barrel near a four-month high, was attributed to attacks by Iran-aligned Houthis on Saudi Arabia and the postponement of Gulf-Iran talks.

This development added to inflation concerns, driving 10-year Treasury yields above the significant psychological threshold of 5% for the first time since October 2023, trading at 4.9895%.

The inflationary pressures were exacerbated by a stronger-than-expected jobs report and a robust increase in consumer prices for August, solidifying the belief among market participants that the Fed would raise rates on Wednesday. Economists surveyed by Reuters also anticipate at least one additional rate hike by the end of March, reversing the cautious "no-change" consensus that had prevailed prior to official data revealing strong inflation data on Friday.

Analysts at BCA noted that the market's outlook on inflation is primarily driven by oil prices, but the overall macroeconomic picture does not support additional hikes beyond those already priced in the yield curve. This suggests limited upward potential for the U.S. dollar, with market sentiment indicating a shift towards a net long position on the Japanese yen, for the first time since February.

Other currencies, including the New Zealand and Australian dollars, showed minor declines against the U.S. dollar, while the offshore yuan held steady near its strongest level in over three years.