Dollar hits 1-year high as traders anticipate rate rises

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Newsletter: Unhedged

The US dollar traded at its strongest level in a year against major currencies as traders banked on persistent inflation driving the Federal Reserve closer to its first pandemic-era interest rate rise.

The dollar index, which measures the US currency against six others including the euro and sterling, hit its highest level since September 28 2020, following days of choppy trading on financial markets after central bank officials signalled the end of ultra-supportive monetary policies.

Headline inflation in the US is running at around a 13-year high after economies reopened from last year’s shutdowns, creating supply chain bottlenecks.

The Fed last week raised its inflation forecasts and indicated that it would reduce its $120bn a month of bond purchases that have boosted lending and spending through Covid-19. It said half of its monetary policymakers now expected an interest rate rise next year.

Fed chair Jay Powell, who for much of this year characterised price pressures as transitory, on Wednesday warned that “frustrating” inflationary pressures would persist.

“We are seeing persistent and broad-based inflation in the US and Europe,” said Tatjana Greil Castro, co-head of public markets at bond investor Muzinich.

Powell has now “prepared the market” for the Fed to reduce its bond purchases from November, which “leaves open the possibility of the first rate hike being delivered during the second half of next year”, MUFG Bank currency analyst Lee Hardman said.

The income yield on the benchmark 10-year US Treasury note, which informs the valuations investors are willing to pay for higher-risk equities, was flat at 1.527 per cent on Thursday but has climbed from around 1.3 per cent just over a week ago.

“It will easily reach 2 per cent, if not a little bit higher,” by the end of the year, Greil Castro said, as investors adjusted the income returns they sought from the fixed interest securities in line with bets on interest rates and inflation.

In equities, Europe’s main stock market was on track to end the month more than 3 per cent lower. The Stoxx 600 rose 0.3 per cent by early afternoon in London, but remained 2.7 per cent lower for September after hitting a record high in the first week of the month.

Wall Street stock markets, which endured their worst day of selling since May on Tuesday, were on course to inch higher in early New York dealings.

Futures markets signalled that the S&P 500 share index would rise 0.3 per cent. Contracts tracking the technology-focused Nasdaq 100 rose 0.4 per cent

“We’re staying in the buy-the-dip camp,” said Marija Veitmane, equity strategist at State Street Global Markets, referring to the practice of topping up on shares of strong companies during periods of stock market volatility.

While there was “a lot of talk” about the Fed tapering its monthly purchases of Treasuries and mortgage-backed securities, Veitmane added, “what we will get is a lower addition of liquidity [into markets], not a withdrawal.”

Companies in the US and Europe, having benefited from cheap money during the pandemic, were now “awash with cash”, and able to invest in their businesses which was “exciting for long-term profitability”, Veitmane said.

Brent crude, the international oil benchmark, ticked 0.8 per cent lower to $78.02 a barrel after breaching the $80 mark for the first time in almost three years earlier this week.