Oil Price Rebound Feeds Inflation Fears, Fuels Dollar Strength

The recent rebound in West Texas Intermediate crude oil prices has added to concerns about inflation in the US, lifted Treasury yields, and strengthened the dollar. According to Fiona Cincotta, a senior market analyst at StoneX, this development is significant because it reinforces the Federal Reserve's view that interest rates may need to be hiked several more times to bring inflation back to its 2% target.

The US composite PMI has reached its strongest level in over five years, which has lifted market-implied odds of an October Federal Reserve hike to 75% from 50%. Meanwhile, the 10-year Treasury yield has pushed to fresh 19-year highs. As a result, currency traders are seeing a dollar supported by multiple factors, with oil now being part of the same inflation story as the Federal Reserve's own signals.

On the other hand, the Japanese yen has weakened more than 3% in two weeks despite a Bank of Japan hike to a 31-year high. Markets do not seem convinced that further tightening is coming from the Bank of Japan, which has led to a decline in the yen's value. In contrast, the Federal Reserve raised rates by 25 basis points and signaled two more hikes, a path that oil-driven inflation concerns only reinforce.