Dollar charges to over one-week peak as Fed hike bets hit 92% while euro, yen sag

The U.S. dollar climbed to its highest level in over a week on Tuesday, as foreign exchange desks aggressively built in bets for a Federal Reserve interest rate increase this week amid rising Treasury yields and a fresh surge in crude oil prices. 

The Dollar Index, which tracks the greenback against a basket of six major currencies, inched up 0.24% to hover at over one-week highs around 99.60.

In contrast, the euro languished at one-month lows, down 0.1% on the day to trade near $1.1539. Foreign exchange traders continued to weigh euro area stagflation risks against a hawkish greenback, even after the European Central Bank increased borrowing costs by a quarter point to 2.50% last week.

The Japanese yen pulled further away from its recent peaks, down 0.3% to touch an over one-week low of 154.82 per dollar. The retreat extends the yen’s pullback from its seven-month high of 152.89 reached last week, as markets braced for the Bank of Japan’s monetary policy decision on Friday.

A dense sequence of major central bank policy meetings dominates global currency bourses this week. The Federal Reserve begins its two-day FOMC meeting later on Tuesday, followed by the Bank of Japan on Friday, with both central banks widely expected to lift borrowing costs to ward off a damaging spike in inflation.

Financial markets are now treating a Fed rate hike on Wednesday as almost certain. Pricing monitored via CME FedWatch shows a 92.1% probability of a 25-basis-point increase into the 3.75%-4.00% range, up from about 60% last week. Money markets are also discounting a 53.4% chance of a follow-up rate hike at the October meeting.

The dollar’s upward march came as renewed gains in commodity bourses pushed sovereign borrowing costs higher across major economies.

Benchmark U.S. 10-year Treasury yields climbed above 5% on Tuesday for the first time since 2007, while Brent crude climbed past $113 a barrel following fresh attacks on Saudi Arabian pipeline infrastructure and Houthi strikes in the Red Sea.

"Markets are pricing a Fed hiking cycle even as energy input costs threaten to entrench second-round inflation," DBS analysts noted in a client advisory, while cautioning against chasing the dollar’s pre-FOMC rally given that two senior Fed officials had signaled a willingness to hold rates before entering their blackout period.

Across the Pacific, the yen’s pullback comes as traders debate whether the BOJ will signal a faster pace of subsequent tightening after delivering an expected 25-basis-point hike to 1.25% on Friday.

The Japanese currency has gained about 4% this month, driven by structural capital repatriation and a surge in Japan’s 10-year government bond yield to a 30-year high of 3.025%.