United States Dollar Index retreats from post-CPI high, all eyes on Fed
- The US Dollar pulls back after briefly rising in reaction to the latest CPI figures.
- US CPI rises 0.4% MoM in August, while core inflation increases 0.3%.
- Traders now await whether the Fed delivers the rate hike priced into markets.
The US Dollar Index (DXY) reverses earlier gains on Friday as a pullback in longer-dated US Treasury yields outweighs support from the latest US Consumer Price Index (CPI) report, which strengthened expectations that the Federal Reserve (Fed) will raise interest rates next week. At the time of writing, the index trades around 99.11 after briefly climbing to 99.36 in the immediate reaction to the data.
The headline Consumer Price Index (CPI) rose 0.4% MoM in August, matching market expectations but accelerating sharply from the 0.1% increase recorded in July. Annual inflation held steady at 3.4%, also in line with forecasts.
Core CPI, which excludes volatile food and energy prices, increased 0.3% MoM, above the 0.2% forecast and the previous reading of 0.2%. Annual core inflation eased to 2.4% from 2.5%, matching expectations. The report also showed that gasoline prices rose 3.9% and accounted for more than one-third of the monthly increase in headline inflation.
Following the release, traders raised their bets on a rate hike at the Fed’s September 15-16 meeting, with the CME FedWatch Tool showing an 88% chance of a 25-basis-point increase, up from 67% earlier in the day.
However, the US Dollar struggles to capitalise on the hawkish repricing as a sharp decline in Oil prices pulls longer-dated Treasury yields back from multi-year highs. The benchmark 10-year US Treasury yield trades near 4.94% after briefly reaching 4.99%, its highest level in around three years. Meanwhile, West Texas Intermediate (WTI) Oil trades near $96.50 after briefly climbing above $100, down about 4% on the day.
However, the policy-sensitive two-year yield holds higher near 4.63%, around levels last seen in July 2024, reflecting increased expectations of an imminent rate hike. The elevated front-end yield helps limit selling pressure on the Greenback.
The Fed meeting next week is now the main focus. Fed officials have repeatedly stressed that inflation has stayed too high for too long and reaffirmed their commitment to bringing it back to the 2% target. Elevated Oil prices complicate that task, leaving markets to assess whether policymakers see the energy shock as persistent enough to deliver the rate hike traders expect or opt for another hold.
Fed FAQs
Monetary policy in the US is shaped by the Federal Reserve (Fed). The Fed has two mandates: to achieve price stability and foster full employment. Its primary tool to achieve these goals is by adjusting interest rates. When prices are rising too quickly and inflation is above the Fed’s 2% target, it raises interest rates, increasing borrowing costs throughout the economy. This results in a stronger US Dollar (USD) as it makes the US a more attractive place for international investors to park their money. When inflation falls below 2% or the Unemployment Rate is too high, the Fed may lower interest rates to encourage borrowing, which weighs on the Greenback.
The Federal Reserve (Fed) holds eight policy meetings a year, where the Federal Open Market Committee (FOMC) assesses economic conditions and makes monetary policy decisions. The FOMC is attended by twelve Fed officials – the seven members of the Board of Governors, the president of the Federal Reserve Bank of New York, and four of the remaining eleven regional Reserve Bank presidents, who serve one-year terms on a rotating basis.
In extreme situations, the Federal Reserve may resort to a policy named Quantitative Easing (QE). QE is the process by which the Fed substantially increases the flow of credit in a stuck financial system. It is a non-standard policy measure used during crises or when inflation is extremely low. It was the Fed’s weapon of choice during the Great Financial Crisis in 2008. It involves the Fed printing more Dollars and using them to buy high grade bonds from financial institutions. QE usually weakens the US Dollar.
Quantitative tightening (QT) is the reverse process of QE, whereby the Federal Reserve stops buying bonds from financial institutions and does not reinvest the principal from the bonds it holds maturing, to purchase new bonds. It is usually positive for the value of the US Dollar.
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