Dollar perched at two-month high as hot PMI fuels inflation fears, rate hike bets

The US dollar reached a two-month high on Thursday due to a robust manufacturing reading that heightened concerns over inflation and speculation of further interest rate hikes. Treasury yields climbed across the curve, further bolstering the dollar's strength. The euro dipped to a two-month low at US$1.1378, while the British pound approached a three-month low at US$1.3231. The dollar index hovered at a two-month peak of 101.1, indicating a strong dollar.

The purchasing managers index report released earlier showed a stronger than anticipated performance, adding to inflation worries and causing bond selling as yields breached the 5% mark for the first time since 2007. Federal Reserve Governor Michael Barr indicated on Wednesday that the central bank is likely to implement additional rate hikes. This forward guidance from the Fed's governor spurred traders into betting on a second consecutive policy tightening next month.

Chris Weston, head of research at Pepperstone, noted that the US dollar's attractiveness is reinforced by the US economy's strength and the Fed's aggressive rate-hike stance. He emphasized that rising inflationary risks and a thriving economy make the Federal Reserve more likely to deliver further rate hikes. As the signs of an overheating US economy become more apparent, policymakers might need to tighten monetary policy further if inflation continues to surpass expectations, Weston stated.

The jump in oil prices, nearly 4%, was driven by Iran's President vowing not to back down, while the US President's diesel export ban further fueled concerns. This surge in oil prices amplified inflation risks and heightened expectations of additional rate increases when the US central bank convenes again in October, according to CME Group's FedWatch Tool. The probability of a rate hike now stands at nearly 70%, up from 50% a week ago.

The Japanese yen hovered near its three-week low at 157.9, prompting traders to anticipate possible intervention by the Bank of Japan. The Bank of Japan had recently raised rates to a 31-year high, but traders felt this move was inadequate. Japan's manufacturing activity slowed down in September, with output and new orders weakening. In Australia, the local currency slipped 0.07% to US$0.7035 amid anticipation of jobs data, while the New Zealand dollar remained unchanged at US$0.5676.

Lastly, the offshore Chinese yuan remained flat at 6.7119 per dollar as attention turned to Chinese President Xi Jinping's first visit to the US in three years. This high-stakes visit, laden with discussions on trade, technology, Taiwan, and Iran, will test the diplomatic relations between the two nations.