Dollar Set for Best Week in Two Months as Dovish Fed Bets Unwind

The dollar is set for its since early August as resilient US data forced traders to reassess the Federal Reserve’s scope for interest-rate cuts, with attention turning to Friday’s inflation report .

The traded little changed after hitting a three-week high on Thursday, leaving it up more than 0.7% in the past five days. The yield on policy-sensitive two-year Treasuries is poised for its biggest weekly advance since early July.

Investors are reassessing the scope for aggressive rate reductions after US jobs and came in better than expected on Thursday. Having nearly priced two quarter-point Fed cuts by year-end, money markets now see the odds closer to a coin toss.

August’s personal consumption expenditures price index — the Fed’s preferred inflation gauge — is due later Friday.

“The data serve as a warning sign for the Fed,” Danske Bank strategists wrote in a note, predicting the dollar and short-end yields could continue to climb in the near term. “With growth momentum proving stronger than expected, market focus could swing back to the inflation mandate.”

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While the greenback pared some of its advance on Friday, any upside surprise in the PCE numbers could quickly put the rally back on track and cement the dollar’s best run in months.

“With the US rates market still aggressively priced for Fed rate cuts, US data will have to be weak to weigh on the dollar,” wrote David Forrester , a senior strategist at Credit Agricole.

Options markets reinforced the picture.

Dollar sentiment — measured by so-called risk reversals — has flipped bullish across tenors, with one-year contracts at their most positive in two months. That shift comes as Group-of-10 currency volatility sank to its lowest in 14 months, a dynamic that supports the dollar given their strongest inverse correlation since 2018.

Hedge funds are showing less appetite to fade this dollar rally than past episodes, choosing instead to wait out quarter-end flows before reengaging, according to currency traders familiar with the transactions who asked not to be identified because they aren’t authorized to speak publicly.

After the data on Thursday, the dollar hit its strongest since May versus the Canadian dollar, the highest since April against the New Zealand dollar, and its strongest in nearly two months versus the yen.