Why Is The US Dollar On Fire Despite Fed's Steady Interest Rate Signals?

The U.S. dollar is currently on an eight-week winning streak, flexing its muscles to reach levels not seen since February 2023. While this surge may suggest imminent rate hikes, the latest Federal Reserve signals and economic data actually tell a different tale.

The Dollar Index Takes Off

The U.S. dollar index, as closely tracked by the Invesco DB US Dollar Index Bullish Fund ETF UUP, flirted with the 105 mark on Tuesday, marking a milestone not witnessed in five months.

Despite the dollar’s ascent, Fed futures are singing a different tune, with a 95% probability that the Fed will keep rates unchanged at the upcoming FOMC meeting. November’s odds? They continue to indicate traders bet on rates to stay on hold at about a 60% probability, according to CME Group.

Chart: U.S. Dollar Index On The Longest Weekly Winning Streak Since July 2014

Fed Speakers: Tuesday Insights

Two notable Fed speakers stepped into the spotlight on Tuesday, shedding light on their outlook for interest rates.

Fed Gov. Christopher Waller, a voting member of the FOMC, hinted the Fed can afford to “proceed carefully” in light of recent positive economic data. His sentiment echoed Fed Chair Jerome Powell’s words from the Jackson Hole Symposium in August. Waller’s cautiously optimistic tone suggests that the Fed may adopt a wait-and-see approach, especially with two consecutive favorable inflation reports.

Loretta Mester, president of the Federal Reserve Bank of Cleveland and a non-voting member in 2023, emphasized there’s more work to be done, particularly in tackling stubborn service inflation. Mester, known for her hawkish stance, pointed to unexpected demand strength that could necessitate a more restrictive policy. She also noted the recent surge in oil prices, which could fan the flames of inflation again.

Why Is the Dollar on Fire?

The dollar’s rise depends on both fundamental and technical factors.

While reduced rate hike expectations might appear to undermine the dollar, it’s crucial to consider its performance relative to other currencies.

The euro and the pound, for instance, faced headwinds as recession risks loom over Europe. Meanwhile, the U.S. economy maintained a Goldilocks-like balance, neither too hot nor too cold, minimizing the recession specter.

Technically, the dollar’s chart also provided bullish signals. The greenback decisively crossed both its 50 and 200-day moving averages in the past month, with the 200-day average offering solid support throughout.

Chart: U.S. Dollar Index, 50-Day & 200-Day Moving Averages