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

The US dollar reached a two-week high on Tuesday as rising oil prices pushed up Treasury yields and heightened expectations of a Federal Reserve interest rate increase this week. The greenback also benefited from weakened risk appetite following a drop in stock markets, with AI-related shares facing pressure after industry leaders called for more cautious development to mitigate potential threats to humanity.

Market projections now suggest a Fed rate hike on Wednesday is virtually certain, with the CME's FedWatch tool pricing a roughly 93% probability of such a move, marking the first increase in over three years.

Christopher Wong, an FX analyst at OCBC, noted in a statement that the combination of higher oil prices, elevated US yields, and diminished risk appetite supported the dollar's overall strength. While near-term support may persist, further gains in the dollar's value are likely to hinge on the Federal Reserve's decision to maintain the possibility of additional rate hikes.

The dollar index, which gauges the greenback against a basket of currencies, stood at 99.55 at the close of trading. The euro weakened slightly to $1.1538, while the British pound slipped to $1.3494. The Japanese yen also retreated from a seven-month peak, declining roughly 0.2% to 154.72 ahead of an anticipated Bank of Japan rate hike on Friday.

Oil prices surged to $107 a barrel, near a four-month high, following an attack by Iran-aligned Houthis in Yemen on Saudi Arabia and the postponement of Gulf-Iran talks. This surge in oil prices exacerbated inflation concerns and propelled 10-year Treasury yields past the psychologically significant 5% mark for the first time since October 2023, trading at 4.9895% in the prior session.

Inflation pressures were further fueled by a stronger-than-anticipated jobs report and a surge in consumer prices for August, reinforcing market confidence in the Fed's decision to raise rates on Wednesday.

Reuters' economists also forecast at least one more interest rate hike before the end of March, contradicting a cautious "no-change" consensus that had prevailed prior to the release of official data on Friday, which indicated robust inflation. The inflation outlook is now primarily driven by oil prices, but analysts at BCA suggest that the macroeconomic landscape does not necessitate additional rate hikes beyond those already priced into the yield curve.

Furthermore, markets are virtually certain of the Bank of Japan's rate hike on Friday. Sentiment towards the Japanese yen is shifting, with speculators adopting a net-long position in the currency for the first time since February. The New Zealand dollar and the Australian dollar both slipped slightly, ending the day at $0.5769 and $0.7133, respectively.

Meanwhile, the offshore yuan remained stable at 6.708 per dollar, near its strongest level in over three years, as investors await industrial output and retail sales data later in the trading session.