The US dollar began the new week close to a strong level after a sharp rise last week. The Dollar Index stayed above 100 on Monday, September 21, after it gained more than 1% in the previous week.
The move came after the Federal Reserve raised US interest rates and gave a firm signal on future policy. Traders now expect the US central bank to keep rates high for longer and may raise them again if price pressure stays strong.
The Dollar Index, also called DXY, measures the value of the US dollar against six major currencies. A level above 100 shows that the dollar has recovered from its earlier weakness and has found fresh support from the latest shift in US monetary policy.
On Monday, the index was close to 100.23, while another market report placed it near 100.35. It had reached a seven-week high of 100.564 on Friday.
The dollar has now entered a new phase in which traders must decide how much more strength the recent Fed move can create.
The Fed Gives the Dollar Fresh Support
The main reason behind the dollar’s latest rise is the Federal Reserve.
Last week, the US central bank raised its interest rate by 25 basis points. This was the first US rate increase in three years. The move was widely expected, but the message from the Fed after the decision gave the market a stronger signal.
The central bank made it clear that inflation remains a major concern. Officials also left the door open for more rate increases.
That message matters because higher US interest rates can make dollar assets more attractive. Investors who hold US bonds or other dollar assets may receive higher returns when rates rise.
As a result, demand for the US currency can increase.
The Fed’s latest decision also changed the market view of what could happen later this year. Traders now see a real chance of another rate increase in October. Reuters reported that markets priced a 55% chance of a hike at the Fed’s next meeting, up from 43% a week earlier.
Another market estimate put the October odds at 56.5%, while the chance of at least one more hike this year was close to 88%.
Why Higher Rates Help the Dollar
Interest rates have a major role in the foreign exchange market.
When US rates rise, investors can earn more from some US assets. This can increase demand for the dollar because investors need US currency to buy those assets.
The effect can be even stronger when other major central banks offer lower rates or give a softer policy message.
The current situation is slightly different because several other central banks have also become more firm on inflation.
The Bank of Japan raised its rate to 1.25% last week, its highest level in 31 years. The European Central Bank has also faced pressure from higher inflation linked to the long conflict in the Middle East. The Bank of England has also signalled that tighter policy may be needed.
This means the dollar cannot rely only on higher US rates.
It also needs a clear advantage over other major currencies.
For now, US policy has given that advantage some support.
The Dollar Index Stays Above 100
The Dollar Index is now one of the main numbers in the forex market.
It rose more than 1% last week and held above 100 early on Monday. FXStreet reported that the index was near 100.35, with a short-term positive trend after a move above its 20-day exponential moving average at 99.63.
The index also reached 100.564 on Friday, its highest point in seven weeks. On Monday, it remained close to 100.23 to 100.35.
This shows that the dollar has not given back much of its recent gain.
That is important because the first reaction after a major central bank decision can often fade. Traders may take profits after a sharp move, which can push a currency lower.
The dollar did ease at points after the Fed decision last week, but it later found fresh support.
Reuters reported that the dollar index was still about 1.4% higher than one week earlier on September 17.
The latest price action suggests that the market still sees value in holding the dollar.
The Fed’s Message Matters More Than the Rate Move
The 25-basis-point rate increase itself was not a surprise.
What mattered more was the message around it.
The Federal Reserve has made it clear that inflation remains too high. Fed Chair Kevin Warsh has stressed the need to control price pressure, while Minneapolis Fed President Neel Kashkari has also said that inflation is a concern beyond higher oil prices.
This point is important.
Oil prices have been a major source of inflation pressure because the Middle East conflict has affected energy markets. But Fed officials have warned that the problem is not limited to energy.
Services inflation also remains a concern.
If inflation stays high across several parts of the economy, the Fed may have less room to cut rates or pause for a long period.
That can keep US yields high.
Higher Treasury yields can then support the dollar.
US Treasury Yields Add to Dollar Support
The bond market has also played a major role in the recent dollar move.
US Treasury yields rose around the latest Fed decision. Reuters reported that two-year Treasury yields had risen as much as 36 basis points over the previous two weeks by September 21.
Short-term US yields are closely linked to expectations for Federal Reserve policy.
When traders expect more rate increases, short-term bond yields can rise.
Higher yields can then support the dollar.
This link helps explain why the currency reacted so strongly to the Fed decision.
The dollar and US interest rates have moved closely together in recent sessions. Reuters quoted market strategist Marc Chandler, who said that the dollar was moving with US interest rates at the moment.
If Treasury yields rise again, the dollar could receive more support.
If yields fall, some of the recent dollar strength could fade.
Markets Are Watching the October Fed Meeting
The next major test for the dollar will be the Federal Reserve’s October meeting.
The market has already raised its expectations for another rate increase.
The latest CME FedWatch figures cited by Reuters show a 55% chance of an October hike. That is a notable rise from 43% one week earlier.
Another FXStreet report put the probability of at least one more rate increase this year at close to 88%.
These figures show how quickly expectations have changed.
However, a market probability is not a promise from the Federal Reserve.
The final decision will depend on new economic data, especially inflation, employment and economic activity.
If future data shows that price pressure remains strong, the case for another increase could grow.
If inflation falls faster than expected, traders may reduce their rate expectations.
That could put some pressure on the dollar.
US Economic Data Takes Centre Stage
With the Fed decision now behind the market, attention will turn to fresh US economic figures.
On Monday, traders were due to receive the Chicago Fed National Activity Index for August. Market participants were also set to follow comments from Federal Reserve officials.
These events matter because traders want clues about the next Fed move.
Strong economic data can support the idea that the US economy can handle higher rates.
Weak data can have the opposite effect.
The Fed therefore faces a difficult task.
It must control inflation without placing too much pressure on economic growth.
For the dollar, this balance is very important.
A strong US economy plus high inflation could keep the Fed firm.
A weaker economy plus lower inflation could reduce the need for further rate increases.
Yen Remains the Dollar’s Main Focus
The Japanese yen has been one of the biggest sources of dollar strength in recent days.
USD/JPY rose to around 157.20 on Monday. The yen has faced pressure even after the Bank of Japan raised its policy rate to 1.25%.
The yen fell about 2% last week, which added to concerns about possible action from Japanese authorities.
Reports of a rate check by Japanese officials also raised the risk of currency intervention.
For the dollar, this has helped keep USD/JPY high.
However, intervention risk could also create sudden moves in the pair.
If Japan decides to buy yen and sell dollars, USD/JPY could fall quickly.
This makes the yen one of the most important currencies to watch as the dollar holds near its recent highs.
Euro and Pound Face Their Own Challenges
The dollar’s strength is not only about US policy.
Weakness in some other major currencies has also helped the greenback.
The euro was close to $1.149 on Monday. Political developments in Germany added another layer of pressure to the single currency.
Sterling was near $1.339 and remained close to recent lows.
Both currencies also face their own interest rate questions.
The European Central Bank and Bank of England must deal with inflation and the economic effect of the Middle East conflict.
If other central banks also take a firm approach, the gap between US rates and rates elsewhere could narrow.
That could reduce some of the dollar’s advantage.
For now, however, the latest Fed message has given the US currency a clear source of support.
Oil Prices Could Change the Picture
Oil prices are another factor for the dollar.
The Middle East conflict has kept energy markets under pressure. Brent crude remains above $100 per barrel, although oil prices eased on Monday after some signs of improved supply.
Higher oil prices can create more inflation pressure.
That can make the Fed more cautious about cutting rates.
At the same time, the US economy is less exposed to imported energy costs than some other major economies. This can sometimes give the dollar support when energy prices rise. Reuters noted this relationship in its recent forex report.
The oil market therefore remains an important part of the dollar story.
A sharp rise in crude could push inflation expectations higher and strengthen rate hike bets.
A sustained fall in oil could have the opposite effect.
What Traders Will Watch Next
The US dollar enters the new week with a clear change in market tone.
The Dollar Index is above 100 after a gain of more than 1% last week. It also reached 100.564 on Friday, its highest level in seven weeks.
The main reason is the Federal Reserve’s new policy message.
The central bank raised rates by 25 basis points and left the door open for another increase. Traders have responded by raising their bets on another move in October.
Still, the dollar’s next move will depend on new evidence.
US inflation data, employment figures, economic activity and comments from Fed officials can all change market expectations.
Treasury yields will also remain important because they have a close link with the dollar.
The yen will need close attention because of possible Japanese intervention. The euro and pound will also remain sensitive to their own central bank decisions and political risks.
Dollar Faces a New Test
The US dollar has started September 21 from a position of strength, but the market now faces a fresh test.
The currency has already gained more than 1% in one week. The Dollar Index has moved above 100 and reached 100.564. At the same time, traders have raised the chance of another Federal Reserve rate increase.
The key question now is whether the US economy will give the Fed enough reason to keep its firm policy stance.
If inflation remains high and growth stays solid, the market may continue to expect higher US rates.
If economic data weakens or inflation falls, those expectations could change.
For now, the dollar has support from the Fed, US Treasury yields and stronger rate hike expectations. The currency has also gained from weakness in the yen and other major currencies.
The next few weeks will show whether this is the start of a longer period of dollar strength or simply a strong reaction to the latest Federal Reserve decision.
For forex traders, the message is clear: US interest rates, inflation data and Fed comments will remain at the centre of the dollar story as September moves forward.
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