Powell’s Resolve to Raise Rates Spells Further Dollar Strength

(Bloomberg) -- Federal Reserve Chair Jerome Powell's vow to contain inflation with higher interest rates is holding, and that may boost the dollar.

The two-year Treasury note yield surged 17 basis points on Wednesday after Powell backed a quarter-point rate hike this month despite uncertainties stemming from Russia's invasion of Ukraine. Although yields fell across the curve in Asia on Thursday, overnight-indexed swaps price in more than five Fed rate hikes this year, in stark contrast with the prospect of continued accommodative policy in the euro zone and Japan.

“U.S. inflation is unlikely to accelerate further from here, while the policy rate and bond yields will rise, so real yields have entered a sustained upward trend,” said Koji Fukaya, a fellow at Market Risk Advisory in Tokyo. “The dollar will go up.”

The U.S. currency's track record in largely following differentials in inflation-adjusted 10-year yields is a good indicator of strength ahead. Over the past two years, the Dollar Index has tracked the gap in yields between the U.S. and the gauge's members, excluding Switzerland, according to data compiled by Bloomberg. That spread has widened almost half a percentage point this year, while the dollar gained about 2%.

Fukaya sees the Dollar Index rising another 1.5% to 99 this year, compared with 97.524 on Thursday.

U.S. inflation, as measured by the personal-consumption expenditures index, probably will peak at an annual 5.6% in the January-March period before slowing to 3% in the fourth quarter, economists forecast.

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