Dollar Gains Most in Two Months as Yield Jump Fuels Bullish Bets

(Bloomberg) -- A jump in U.S. Treasury yields helped the dollar post its largest daily gain in nearly two months on Monday, signaling that the currency could extend last year's rally as markets anticipate the Federal Reserve will initiate a cycle of interest-rate increases this year.

The Bloomberg Dollar Spot Index climbed 0.6% in the first trading session of 2022, erasing last week's losses, amid an across-the-board selloff in Treasuries. That drop pushed 10-year yields up by as much as 10 basis points, the largest gain since early December.

Markets expect the Fed to raise its benchmark overnight rate three times over the course of the year, with the first move anticipated in May. The prospect of higher yields has made the long-dollar bet one of the most popular currency trades for 2022, with leveraged funds' net-long positioning at its most bullish since June 2019.

While some traders see limited dollar gains in the coming year, a technical indicator that measures the dollar's relative strength suggests the currency may have more room to run even after posting its biggest annual gain in six years. That index is trending upward but is still near the middle of its range, far from levels that would be seen as a sign that the currency has gained too much.

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Still, market liquidity is thin and the dollar has yet to break through 2021's high, a closely watched technical threshold that would indicate the advance may continue. A move past that high, or about 1% over Monday's level, could signal a more sustained breakthrough.

Erik Nelson, a currency strategist at Wells Fargo in New York, said he sees the Bloomberg dollar index breaking above 1,200 in the next month or two, about a 2% increase from its current level.

“The Fed and other central banks remain the biggest driver of FX for the time being in our view,” he said. “And this week's FOMC minutes will be useful in gauging the potential timing both of the first rate hike and potential balance sheet normalization.”