Dollar Surges as Fed Prepares for New Tightening Cycle

The US dollar has surged in response to inflation data and rising tensions in the Middle East. The escalation of attacks by Yemeni Houthis on Saudi Arabia's East-West pipeline, which has a capacity of 7 million barrels per day, threatens to reduce oil supplies to the global market and push Brent prices towards $120 per barrel.

As a result, the Federal Reserve will be forced to initiate a new cycle of monetary tightening. According to CME derivatives, the probability of a rate hike has increased from 60% before the release of inflation data to 87%. This has reignited interest in the US dollar and led to speculation that the Fed will continue to tighten policy until it defeats inflation.

The market currently prices in two rate rises and a small probability of a third by March 2027. If updated FOMC forecasts indicate more than this, the dollar index is expected to gain fresh momentum. This would be a significant development for USDJPY, which could see a return to levels around 163, as forecasted by Morgan Stanley.