Dollar Index Rises Amid Fed Rate Hike Expectations

The US Federal Reserve is facing a crucial test this week as inflation data came in hotter than expected, strengthening the case for a rate hike next week.

US headline CPI rose by 0.4% month on month, while core inflation increased to its fastest pace since April at 0.3%. The dollar index briefly reached 99.19 after the release, and the implied probability of a September hike rose to 71%, making a Fed hold the bigger market surprise.

Despite the initial rise in the dollar, its disconnect from oil and Treasury yields continues to cloud the outlook. Higher crude prices and rising yields would normally offer strong support, but the dollar has struggled to follow either signal. A growing US policy premium has taken hold of FX pricing, weakening these traditional relationships.

The Canadian dollar is also facing pressure, with USD/CAD trading near 1.3870 after reaching 1.3882. Hotter US inflation widened the US-Canada two-year yield spread to about 127 basis points, while Canada's weak labour market leaves investors questioning whether the economy can absorb aggressive hiking.