Dollar Gains as Inflation Data Bolsters Fed Rate Hike Expectations

The U.S. dollar strengthened on Friday after a key inflation report accelerated bets that the Federal Reserve will raise interest rates next week. The U.S. Dollar Index (DXY), which measures the greenback against a basket of six major currencies, gained 0.1% to 99.13 as traders reacted to the latest economic data.

Inflation Data Fuels Hawkish Fed Bets

Data from the U.S. Bureau of Labor Statistics showed the consumer price index (CPI) remains persistent. In August, headline CPI rose 0.4% month-over-month, while core CPI, which excludes volatile food and energy prices, increased 0.3%.

Following the release, market expectations for a quarter-point rate hike by the Federal Open Market Committee (FOMC) surged. The probability of such a move jumped to nearly 87%, up from about 69% before the data, according to the CME FedWatch tool. This sentiment was reinforced by other recent indicators, including a strong nonfarm payrolls report and hawkish commentary from Fed Chair Kevin Warsh at the Jackson Hole conference.

"Our baseline view remains for a hike next week and our confidence in this call increases with the (CPI) release," said David Doyle, head of economics at Macquarie, in a note. "A dovish surprise was required for a hold to become likely after the strong Employment report for August."

Bond Market Reacts as Yields Climb

The U.S. bond market reflected the rising expectations for monetary policy tightening, with yields moving higher. The benchmark 10-year Treasury yield rose 3.2 basis points to 4.976%.

Ad

The shorter-term 2-year Treasury yield, which is more sensitive to near-term Fed policy changes, advanced more sharply, climbing 8.8 basis points to 4.638%. The sell-off in bonds underscores investor conviction that the central bank will act to curb inflation.

Yen Set for Two-Week Winning Streak

In other major currency movements, the Japanese yen continued its rally and was on track for its first two-week winning streak against the dollar since early May. The USD/JPY pair fell 0.5% to 153.72, marking a 1.6% decline for the week.

The yen's strength is driven by growing conviction that the Bank of Japan (BoJ) will raise its borrowing costs at its meeting on September 18. This view was supported by data showing Japan’s Corporate Goods Price Index (CGPI) jumped 7.6% year-over-year in August, indicating that rising import costs are feeding into domestic inflation.

Euro Edges Lower Despite ECB Hike

Across the Atlantic, the euro weakened, slipping 0.1% to $1.1597 and heading for a weekly loss of 0.2%. The decline came even after the European Central Bank (ECB) raised its key policy rate by 25 basis points on Thursday, citing ongoing inflationary pressures from energy prices.