US dollar index (DXY): Rising Treasury yields boost the dollarThe federal funds rate was increased by 75 basis points at the FOMC meeting in November to a range of 3.75 and 4%, as widely expected.
The press conference of Chairman Jerome Powell was more hawkish than imagined. The Fed Chair remarked that there is still work to be done in terms of rate hikes and that the peak of interest rates would be higher than previously thought, probably referring to the median FOMC predictions made in September (4.6%).
The statement also indicated that monetary policy will remain restrictive for some time, and Powell stated that stopping rate hikes is too far away at this point.
In addition, the Chair reaffirmed that the cost of undertightening is higher than that of overtightening. This is due to the fact that the Fed still does not see any meaningful progress on inflation, while the labour market continues to be exceptionally tight.
As a result of Powell's comments, the market has revised its forecast for Fed rate hikes for next year higher, to an expected 5.1%. US 2-year yields spiked to 4.7%, updating fresh highs and reaching July 2007 levels.
Throughout the year, the US dollar DXY index has been increasingly associated with US short-term yields (2-year), with the 90-day rolling correlation coefficient standing at a very high level of 0.91.
US 2-year rates may increase further after the November FOMC meeting to reflect elevated market expectations for the Fed's terminal interest rate. This keeps the dollar on a bullish trend for longer. A rise in 2-year yields up to the 5% mark, would likely imply a rally in the DXY index up to 115 levels.
The speed of the move will hinge on Friday's US non-farm payrolls data and next week's US CPI data. Higher-than-anticipated numbers for the US employment report and inflation will solidify the Fed's hawkish stance and accelerate the dollar's advance.
