US Dollar: Bond market calm limits further gains – OCBC

OCBC strategists Sim Moh Siong and Christopher Wong note the US Dollar (USD) has rallied on higher US Treasury yields, energy prices and a hawkish Federal Reserve (Fed) bias, but still lacks conditions for a decisive move beyond its recent range. Calmer bond markets and potentially contained US inflation could curb further hawkish repricing, leaving the USD supported but without a clear breakout path in the near term.

Dollar supported but capped for now

"To break higher or not? That remains the key question for the USD. The DXY has rallied more than 3% over the past five weeks as markets priced a more hawkish Fed path and rising US Treasury yields amplified concerns about European sovereign debt."

"Our base case remains that the USD should stay well supported. However, we do not yet see the conditions for a sustained breakout from its recent range. Treasury market conditions have become noticeably calmer, with some of the technical factors that amplified the earlier surge in yields appearing to fade. That could reduce an important source of support for further USD gains."

"While inflation remains above the Fed's 2% target and justifies a restrictive policy stance, the need for aggressive tightening is less compelling if inflation is being driven primarily by supply-side factors such as energy costs and AI-related investment rather than overheating demand."

"Today’s CPI report is therefore critical. If the data confirm that underlying inflation pressures remain contained, markets may further scale back expectations for additional Fed tightening, limiting the USD's upside."

"We continue to expect only one additional Fed hike by mid-2027, compared with market pricing that still implies roughly three hikes. Unless inflation surprises materially to the upside, that gap leaves limited room for further hawkish repricing and argues against a decisive USD breakout in the near term."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor. Know more.)