Look who finally woke up.
The U.S. dollar was surging versus major rivals on Thursday, building on gains seen the previous day after Federal Reserve Chairman Jerome Powell refused several opportunities during a news conference to play down the prospect of aggressive interest rate hikes and other measures aimed at getting inflation under control.
“Faced with a tight labor market, strong domestic demand and inflationary pressures that aren’t all down to temporary supply-chain disruption, the Federal Reserve is giving markets free rein to price in more rate hikes, sooner,” pushing the dollar to cycle highs, said Kit Juckes, global macro strategist at Société Générale, in a monthly outlook published Thursday.
The ICE U.S. Dollar Index DXY, +1.32%, which measures the currency against a basket of six major rivals, rose 1.3% to 97.24, hitting a level last seen in mid-2020. After a sluggish start, the index is roaring in 2022, gaining 2.3% so far in January.
The dollar jumped alongside a surge in short-term Treasury yields, which are more sensitive to Fed rate expectations. The yield on the 2-year Treasury note TMUBMUSD02Y, 1.190% was up nearly 10 basis points near 1.171% on Thursday, while fed-funds futures showed traders penciling in more aggressive rate-hike expectations.
With all eyes on the Fed, the dollar likely has more room to rally as traders bump up just how far they expect policy makers to ultimately take the fed-funds rate, Juckes said. Investors have been penciling in a so-called terminal rate below 2%, or around 75 basis points less tightening than the Fed provided after the dollar peaked in late 2016 — a gap that SocGen expects to close.
With Fed policy front and center, the dollar has room to rally as market participants price in a higher terminal rate, Juckes said, but argued that the currency is likely entering the final stage of its up move.
For the longer run, investors may want to look back at the “2017 playbook,” he said.
Back then, talk of tightening by foreign central banks undermined the dollar even as the Fed continued raising interest rates. More recent, the pandemic has driven bond yields lower around the world, robbing nations with big savings surpluses of “easy” returns, he noted.
“As the global economy emerges from the worst of the COVID pandemic this year, the market focus will shift to monetary policy normalization and growth outside the U.S.,” Juckes wrote, with the best currency returns in the second half of this year likely to come from outside the major developed economies.
The dollar’s surge, meanwhile, was having ripple effects across other markets, getting the blame for a slide by gold futures GC00, -2.09% and pulling oil futures CL00, -1.10% back from levels last seen in 2014.
Stock-market investors, meanwhile, were also wrestling with expectations around the Fed’s policy path and economic data, with U.S. equities jumping higher in early trade Thursday, but in keeping with recent choppy trading action, trimmed or gave up strong gains in afternoon action, with the Dow Jones Industrial Average DJIA, -0.31% clinging to a gain of 78 points, or 0.2%, while the S&P 500 SPX, -0.75% edged down 0.1% and the Nasdaq Composite COMP, -1.42% fell 0.5%.