Powell’s resolve to raise rates spells further dollar strength

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 March 2 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 March 3, overnight-indexed swaps price in more than five Fed rate hikes this year, in stark contrast to the prospect of continued accommodative policy in the eurozone and Japan.

“US 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 US 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 US 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 March 3.

US inflation, as measured by the personalconsumption 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.