The US Dollar Index (DXY) extended its gains from the previous session during Asian trading on Friday, holding near the 101.50 mark, its highest level in over three weeks. The primary driver of the recent dollar strength is the rise in oil prices due to increased international energy supply risks, which has prompted a reassessment of US inflation pressures and boosted expectations for future Federal Reserve interest rate hikes.
The dollar has shown relative strength overall this week, outperforming among major currencies. The dollar led gains against the Swiss franc this week, rose more than 1% against the British pound, and also advanced against the Japanese yen and the Canadian dollar, indicating a renewed flow of funds into dollar-denominated assets. Changes in the energy market have become a key factor driving the dollar's strength. During Asian trading on Friday, WTI crude oil prices slipped about 0.5% to trade near $90.60, but remain close to the previous six-week high of $92.25. Higher oil prices have raised global inflation expectations, leading markets to believe the Federal Reserve is unlikely to adopt an accommodative policy in the near term. Current market focus is on risks to two key energy transport chokepoints. Disruptions in the Bab el-Mandeb Strait and the Strait of Hormuz are estimated to potentially affect approximately 27% of the global energy supply flow. If transport disruptions persist, energy prices could rise further, potentially pushing major economies to face renewed imported inflation pressures.
Given the strong correlation between energy costs and inflation expectations, rising oil prices are altering the market's assessment of the Fed's policy path. Previously, investors anticipated that a continued slowdown in US inflation might prompt a policy shift, but recent energy price increases have raised the risk of inflation rebounding, leading markets to re-elevate interest rate expectations.
According to the CME FedWatch Tool, the market currently estimates a roughly 35.8% probability of a rate hike at the Fed's next policy meeting, a significant increase from 11.8% a week ago. However, this probability remains below levels seen during periods of extreme tightening, and the market is still awaiting future economic data to determine whether further tightening is warranted.
The relatively mild US Consumer Price Index (CPI) for June had previously briefly reduced market bets on Fed rate hikes. However, with oil prices rising again, investors are starting to worry that energy costs could reverse the disinflation trend, thereby forcing the Fed to maintain higher interest rates. Meanwhile, geopolitical risks continue to be a significant support factor for the dollar. The current lack of obvious diplomatic progress between the US and Iran leads the market to believe that supply shocks could persist for a longer period. Former US President Donald Trump stated that the US would hold Iran accountable for actions related to Yemen's Houthi group and warned that the involved forces might face "massive military punishment."
Rising risk aversion typically boosts demand for the dollar, especially when global market uncertainty increases, as investors tend to increase their allocation to liquid dollar assets. This is a key reason why the dollar index has been able to reclaim the 101 level. However, the dollar's rally also faces certain limitations. On one hand, the market has already priced in some geopolitical risk premium. On the other hand, if oil prices fail to extend their gains further, or if US economic data shows signs of weakness, interest rate hike expectations could cool down again. From a daily chart perspective, the dollar index has strengthened after breaking out of its previous consolidation range, now trading near 101.50, with moving averages turning bullish, indicating a short-term uptrend. Upward resistance is seen at the 102.00 handle and the 102.50 area; a break above could open the door for further gains. Downside support is near 101.00, followed by the 100.50 area; a break below could lead to a technical correction. On the 4-hour chart, the dollar index has entered a period of consolidation after a sustained rally, with short-term momentum easing. The MACD indicator remains above the zero line, but the histogram bars are shrinking, while the RSI indicator holds in overbought territory, suggesting bulls still have the upper hand. If the index breaks through the 101.80 to 102.00 area, the uptrend could continue; if it falls below the 101.00 support, profit-taking pressure warrants caution.
Final Analysis
The core logic behind the dollar's recent rally has shifted from being purely driven by economic data to being driven by energy inflation risks and safe-haven demand. The situation in the Middle East has intensified concerns about energy supply, keeping oil prices elevated and leading the market to re-evaluate the prospects for Fed rate hikes, providing short-term support for the dollar. The future direction of the dollar will depend on three key factors: whether energy prices continue to rise, whether Fed policy expectations shift further, and changes in global risk sentiment. If oil prices continue to push up inflation expectations, the dollar could maintain its strength. However, if energy risks subside, the market might refocus on the pressures of a slowing US economy. Currently, the dollar index has established a foothold above 101, suggesting a short-term bullish bias, but the 102 area could present significant technical resistance. Investors need to closely monitor the Fed meeting, US economic data, and changes in the energy market, as these factors will determine the next phase of the dollar's direction.
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