Dollar Surges to Two-Month High as Fed Hawkishness Presses European Currencies

The US dollar has reached its highest level in two months after seven consecutive days of gains and a rise of more than 2%. The Federal Reserve's hawkish stance, combined with a strong domestic economy and big tech momentum, is driving the greenback upward. At the same time, European currencies are under pressure due to political risk, while the yen has fallen in seven out of eight days after divisions on the Bank of Japan's policy stance.

The Fed's commentary suggests that concerns over the Middle East conflict and elevated energy prices could lead to higher core inflation via second-round effects, implying that further tightening may be necessary. This has increased the probability of an October rate rise to 54% and two additional increases in 2026 to around 40%. In contrast, markets price an over-81% chance of a Bank Rate move from 3.75% to 4% in November, despite the pound's recent decline ahead of Andy Burnham's budget proposal.

The French-German yield spread has widened beyond European debt-crisis levels, raising speculation about central bank bond purchases and putting pressure on the euro. This has led some analysts to recommend buying out-of-the-money put options on EURUSD as a hedge against escalating eurozone risks. Meanwhile, others suggest going long on USDJPY due to the Bank of Japan's refusal to commit to further rate hikes and the widening monetary policy divergence with the US.