Dollar hits six-mth peak, yields at 2008 highs on hawkish Fed

© Reuters.

Investing.com-- The dollar hit a six-month high against a basket of currencies on Thursday, while U.S. Treasury yields hit multi-year peaks after the Federal Reserve warned that U.S. interest rates will remain higher for longer.

The dollar index and dollar index futures rose about 0.5% each in Asian trade, hitting their highest level since early-March after Fed Chair Jerome Powell flagged at least one more interest rate hike this year. 

While the Fed held rates steady on Wednesday, Powell said that the Fed will cut rates by a smaller-than-expected margin in 2024, amid a recent rise in U.S. inflation. 

Powell’s comments blindsided markets hoping for more monetary easing next year, triggering strong flows into the dollar and out of Treasuries. This saw the 10-year benchmark race to a 15-year high, while 2-year yields jumped to their highest levels since early-2001. 

The Fed’s hawkish outlook comes as U.S. inflation rose for the past two months, reversing a downward trend seen earlier this year. The readings, coupled with signs of a strong labor market and resilience in the U.S. economy, give the central bank more headroom to keep rates higher. 

U.S. rates are now seen at 5.1% next year, indicating only two rate cuts in 2024, as compared to initial expectations of at least four cuts. Such a scenario keeps rates close to the over 20-year highs they currently stand at.

The Fed still expects the U.S. economy to dodge a recession this year, thanks to relative resilience in consumer spending and labor activity. But the two factors also present more upside risks to inflation. 

Still, some analysts held out hope that the Fed will have limited headroom to actually enact more rate hikes. 

“The concern is that economic softness could go too far (as highlighted by some officials in the July FOMC minutes) and heighten the chances of recession. Given this risk and the encouraging signs seen on core inflation and labour costs, we think the data flow gradually weaken the case for a November or December rate hike,” ING analysts wrote in a note.

Despite the hawkish messaging, Fed Funds future rates show markets pricing in only an about 30% chance of a rate hike in November and December. But rate expectations will also be contingent on the path of inflation, a stance that was reiterated by the Fed.