The dollar strengthened notably this week, marking its largest weekly advance in more than three months, following signals from the Federal Reserve that further interest rate increases lie ahead. Robust U.S. economic growth, combined with the central bank's steadfast commitment to combating inflation, has provided substantial support for the greenback.
The Bloomberg Dollar Spot Index climbed 1.1% over the course of the week. During this period, the Fed implemented its first rate hike in over three years while indicating that additional monetary policy tightening could be on the horizon. Analysts at JPMorgan, Standard Chartered, and Brown Brothers Harriman suggest that this policy move has eliminated a key obstacle that had previously been restraining further dollar gains.
From a technical perspective, the Bloomberg Dollar Spot Index consolidated around its 200-day moving average on Wednesday and Thursday, ultimately closing slightly above this critical technical level on Friday. Historical patterns indicate that when the dollar index achieves a decisive daily close above the 200-day moving average, it often paves the way for additional upside. Similar breakthroughs in March and June of this year were both followed by subsequent rallies.
The dollar was on track for its largest weekly gain since the outbreak of the Iran conflict in March, but gains were trimmed as the yen recovered some ground on Friday. This reversal followed reports that the Bank of Japan had conducted rate inquiries, a move typically interpreted by markets as a potential precursor to official currency intervention by Japanese authorities.
Steve Englander, head of global FX research and North America macro strategy at Standard Chartered in New York, noted that the 25-basis-point rate hike appears to have alleviated a primary concern that had discouraged investors from buying dollars. He explained that traders had worried Fed Chair Warsh might avoid raising rates due to pressure from President Trump's administration. Englander believes the rate increase has not only weakened the case for holding long dollar positions but has also increased the risks associated with shorting the currency. He anticipates that with U.S. 10-year Treasury yields potentially climbing to 5.5% over the next 12 months, the path for further dollar appreciation has become increasingly clear.
It is worth noting that prior to this week's Fed decision, speculative currency investors, including asset managers and non-commercial traders, had been trimming their dollar long positions for some time. According to data from the Commodity Futures Trading Commission (CFTC) released on Friday and compiled by Bloomberg, bullish dollar positioning declined for a seventh consecutive week as of September 15.
Despite this momentum, market participants remain divided on whether the dollar can surpass its highs from earlier this year. Elias Haddad, global head of market strategy at Brown Brothers Harriman, pointed out that other major central banks are also tightening their monetary policies, which limits the scope for further policy divergence between the U.S. and other economies. As a result, he argues, the dollar may struggle to reach new cyclical highs. Currently, the Bloomberg Dollar Spot Index remains approximately 1.9% below the 2026 high set on June 24.
Risk reversal indicators suggest that options traders anticipate modest dollar strength over the coming month. However, the implied gains from the options market still fall short of what would be needed to push the dollar index to fresh yearly highs. Nevertheless, the U.S. economic growth advantage relative to other major economies could continue to underpin the currency. Haddad noted that next week's release of the September S&P Global Purchasing Managers' Index (PMI) is expected to show U.S. economic growth still outpacing the eurozone, the UK, and Japan.
Pat Locke, a foreign exchange analyst at JPMorgan, believes that based on several metrics including interest rate differentials, the dollar was undervalued by roughly 2% to 4% heading into this week's Fed meeting. As markets begin to price in the possibility of additional Fed rate hikes, the dollar is experiencing a valuation "catch-up" trade, with gains particularly pronounced against lower-yielding currencies.
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