US Dollar's Strength Tied to Yield Curve Dynamics

The US dollar's value is increasingly tied to the dynamics of the yield curve, according to ING Economic and Financial Analysis. A flatter yield curve is dollar-positive, while a steeper curve is dollar-negative.

With a more hawkish Fed outlook, the dollar is expected to stay stronger for longer. The EUR/USD exchange rate has been trading in a narrow range of 1.13-1.18, largely influenced by US policy settings.

ING's house view now expects a rate hike in September, which could keep short-dated US yields above 4% and support the dollar into year-end. As a result, ING has revised its EUR/USD forecast to 1.16 from 1.18 and raised its USD/JPY target to 160 from 158.

However, if 30-year Treasury yields surge through 5.50%, steepening the yield curve, the dollar could come under pressure. This would likely lead to a generalized rise in volatility and unnerve carry trade positions in high-yield FX.