US Dollar (DXY): Strengthens as Markets Brace for Higher Interest Rates, Debt Ceiling Resolution

Highlights

• DXY gains on bets for higher interest rates, resolution of debt ceiling talks.
• Government bond yields rise as inflation exceeds expectations.
• June interest rate hike becomes a possibility to control inflation.

Overview

The U.S. Dollar is up against a basket of major currencies on Friday after recovering from an early session setback, putting the index on track for a third straight weekly gain. Markets are raising bets on higher-for-longer interest rates to curb sticky inflation and nervously awaiting a resolution to last-ditch U.S. debt ceiling talks.

The U.S. dollar index, which tracks the greenback against six major counterparts, was last up 0.06% on the day at 104.30, just off Friday’s two-month high of 104.34. It is also on track for a weekly gain of around 1.0%.

Rising Bond Yields Amid Inflation Surge

Government bond yields rose on Friday as the Federal Reserve’s preferred measure of inflation increased in April. U.S. personal consumption expenditure (PCE) inflation rose to 4.4% in April year-on-year, from 4.2% in March, and core PCE rose to 4.7%, exceeding economists’ expectations.

Following the data, the U.S. 2-year bond yield, which is highly sensitive to rate expectations, rose sharply to 4.583%.

Inflation Surge Revives June Rate Hike Prospects

The rise in prices puts a June interest rate hike back in play, potentially even exceeding a quarter percent hike as a last-ditch effort by the Fed to control inflation.

Expectations that the Federal Reserve will keep interest rates higher for longer to subdue inflation have been driving the dollar’s recent momentum. Money markets now predict a 42.5% chance of another 25-basis-point rate hike at the next policy meeting, while expectations of rate cuts later this year have decreased.

Markets Anxious as Default Risk Looms Before Holiday Break

Talks between President Joe Biden and top congressional Republican Kevin McCarthy on Thursday helped ease jitters, but markets remain on edge due to the risk of a default ahead of a long bank holiday weekend in the U.S.

With Monday being a bank holiday, market participants will have to wait until Tuesday, May 30th, to trade positions again. There is a strong belief that Washington needs to make a deal happen today.

Technical Analysis

The main trend is up. The index has extended its current rally to 104.34 on Friday after overtaking 103.631 (R1) earlier in the week. This level is new support. We’re now looking for the rally to possibly extend into 104.406 (R2) over the near-term.

A sustained move under 103.631 (R1) will signal the return of sellers. If this creates enough downside momentum then we could see a retest of 102.405 (S1).  That’s the longer-term support.

It’s been a volatile session so far on Friday. The market started out on the weakside early in the session, coming close to 103.631 support before turning around and moving higher into the close.

For a look at all of today’s economic events, check out our economic calendar.