Fed Tightening Cycle Sparks Dollar Surge and USDJPY Reversal

The US dollar has strengthened in response to inflation data and escalating tensions in the Middle East. Attacks by Yemeni Houthis have forced Saudi Arabia to shut down a major pipeline, which could reduce oil supplies to the global market and drive Brent crude prices towards $120 per barrel.

This situation has led many to believe that the Federal Reserve will begin a new cycle of monetary tightening. The probability of a rate hike has increased significantly, with CME derivatives now pricing in an 87% chance of a policy tightening.

SPECULATORS have been unwinding their net long positions in the US dollar for six consecutive weeks, but this may be about to reverse as interest rates rise. A WSJ journalist who is often considered a Fed insider has suggested that the FOMC will not stop at just one rate hike and will continue to tighten policy until inflation is defeated.

The strengthening of the US dollar has already had an impact on other currencies, with USDJPY bulls launching a counterattack. Morgan Stanley forecasts that the currency pair could return to 163 as speculative short positions in the yen are unwound.