Dollar set for big rise in September, mainly at euro's expense

In September, the US dollar experienced a surge against major currencies, including the euro, Swiss franc, and pound sterling. The strength in the dollar was primarily due to rising US Treasury yields and growing expectations of more Federal Reserve interest rate hikes, driven by inflation fueled by higher oil prices. However, the greenback saw some of its gains diminish after the release of smaller-than-expected US inflation data, which reduced market bets on a rate hike from the Federal Reserve.

Initially, the softer-than-expected data caused bonds to rally and yields to come down, weakening the dollar. John Velis, an FX and macro strategist at BNY, noted that the yield curve appeared steeper, reflecting lower expectations of an October rate hike. Treasury yields, particularly the 2-year note yield, fell as a result. The 2-year yield was last down 0.4 basis points at 4.885 percent.

The US Commerce Department reported that the Personal Consumption Expenditures Price Index, the Fed's preferred inflation gauge, rose 0.3 percent last month, which was lower than economists had forecasted at 0.4 percent. This data prompted traders to price a 37 percent probability of a Fed rate hike in October, down from 70 percent a week earlier, according to the CME's FedWatch tool.

The softer PCE report, coupled with Federal Reserve Bank of New York President John Williams' pushback against the urgency of another rate hike, led to a significant reduction in expectations for consecutive Fed rate increases. This repricing effect pulled Treasury yields lower, narrowing the dollar's yield advantage and providing a clear catalyst for the recent wave of dollar selling.