The dollar index rose sharply, rising nearly 2%, breaking the 104.00 level, boosted by the surge in U.S. government interest rates. In recent days, the yield of U.S. Treasury bonds has risen sharply, but last Friday's rise was particularly large. The U.S. inflation rate rose unexpectedly in May, surging 8.6% year-on-year, hitting a new cyclical high and the highest level since 1981. In this context, the yield curve of all maturities of treasury bonds is rising, and the yield of two-year Treasury bonds has exceeded 3% for the first time since 2008.
Looking forward to this week, the Federal Reserve monetary policy meeting will be the most important moment on the financial calendar. The dollar may still be biased upward, as the market expects that the Federal Reserve may have a more aggressive tightening cycle to cope with the continuous and expanding price pressure.
Before the CPI data was released last Friday, Wall Street expected the Federal Reserve to raise interest rates by 50 basis points at its June meeting, but now the market is betting on a 75 basis point increase. After the release of inflation data, this possibility rose to 40%, compared with only 3% on Thursday.
If these expectations are further strengthened in the next few trading days, the US dollar should further strengthen against other G10 currencies, especially low-yield currencies. Personally, I still tend to believe that policymakers will insist on raising interest rates by 50 basis points to avoid disrupting the market, but may issue very tough forward-looking guidance.
Traders should pay close attention to the information / wording they convey, but more importantly, they should pay attention to the quarterly summary of economic forecasts, including the bitmap of future interest rate forecasts. It is expected that the PCE forecast in 2022 and 2023 may be revised upward, while the GDP forecast should be revised downward, but there is no recession yet.
In terms of the outlook of monetary policy, in view of the recent development of inflation, Fed officials may expect that the rate hike will be greater this year, opening the door to a 50 basis point rate hike at each meeting for the rest of this year. This may be quite beneficial to U.S. Treasury bond yields and the US dollar, making the US dollar index expected to retest its 2022 high and may move towards a multi decade high.