Dollar Strengthens as Market Prices in Double Rate Hikes

The US dollar has gained momentum as speculators begin to return to it in anticipation of an interest rate hike by the Federal Reserve. The market is virtually certain that the Fed will raise rates, with CME derivatives increasing the probability from 60% before the inflation data release to 87%. This rise in probability has reignited interest in the US dollar, with speculators unwinding their net long positions for the sixth week running, falling by $50 billion compared to July.

The strengthening of the US dollar is expected to continue as the market prices in two rate rises and a small probability of a third by March 2027. Morgan Stanley forecasts a return of USD/JPY to 163, which could be a strong headwind for the Japanese economy. The release of inflation data has been a rollercoaster ride for gold, historically a headwind when the Fed starts its monetary-tightening cycle.

The escalation of tensions in the Middle East and attacks on Saudi Arabia's East-West pipeline have pushed oil prices towards $120 per barrel, forcing the Fed to consider tightening its monetary policy. The FOMC will not stop at a single rate rise but continue down this path until it has defeated inflation, according to a WSJ journalist who is considered a Fed insider.