Dollar Rally Resurrected as U.S. Strength Raises Rate Hike Odds

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The dollar rally has a second wind.

After falling 5.9 percent from its peak in March, the dollar has risen each of the past three weeks -- eking out a 0.1 percent gain versus its peers last week as a report showed the U.S. added more jobs than analysts expected, according to the Bloomberg Dollar Spot Index.

While the greenback’s mixed performance this year has reminded analysts and traders that dollar gains are far from sure, bulls are taking comfort in the U.S. economy’s momentum. The Federal Reserve’s plans to raise interest rates have been one of the main drivers of the dollar’s strength, and Friday’s job report prompted debt traders to pull forward their expectations for a hike to September.

“We certainly do expect dollar strength,” said Jennifer Vail, head of fixed-income research in Portland, Oregon, at U.S. Bank Wealth Management, which manages $126 billion.

The dollar advanced 1.2 percent to 125.63 yen last week in New York, and touched 125.86, the highest level since June 2002. The Bloomberg Dollar Spot Index, which tracks the U.S. currency against 10 of its major peers, added 0.1 percent to 1,192.75, while the greenback fell 1.2 percent to $1.1114 per euro.

Hedge funds and other large speculators added to net futures positions that profit from the dollar strengthening against the yen to the most since Jan. 13, according to data released last week from the Commodity Futures Trading Commission.

Economic Reports

Analysts expect reports this week to add to evidence the U.S. economy is strengthening, which would bolster the case for Fed Chair Janet Yellen and her board to raise borrowing costs sooner.

Economists in a Bloomberg survey predict retail sales rose 1.2 percent in May, while the producer price index gained the most since 2012. The University of Michigan’s index of sentiment rose in June, based on a separate survey.

“There’s probably a mental high-fiving between Yellen and other Fed members,” said Minh Trang, a senior foreign-exchange trader at Silicon Valley Bank in Santa Clara, California. “You can see the reaction was almost immediate with the dollar and other Group of 10 counterparts. September rate hike is almost certain at this point.”

Fed Forecasts

Fed fund futures give a 52 percent probability that the central bank will lift rates in September, up from 46 percent before Friday’s jobs report, according to data compiled by Bloomberg.

While dollar bulls are taking heart in expectations for a Fed hike sooner, they may be disappointed by the central bank’s trajectory for how high borrowing costs will rise, according to said John Herrmann, director of U.S. rate strategy at Mitsubishi UFJ Securities USA Inc. in New York.

Some economists expect the Fed to revise its forecasts for borrowing costs downward at its June 16-17 meeting. Fed Governor Lael Brainard said June 2 that a recent run of weak data casts doubt on the strength of the recovery.

“The FOMC needs to offer a more realistic and accurate forecast for the economy and a more reasonable guidance over the prospective path of interest rates,” Herrmann said. “A more gradual trajectory for tightening may damp analysts and strategists with these uber-strong dollar expectations.”

Dollar Forecasts

Fed officials cut their median estimate for the funds rate at the end of 2015 in March to 0.625 percent and to 1.875 percent for December 2016. Their longer-term rate projection was unchanged at 3.75 percent. That sent the dollar down that day by the most in six years.

“The dollar is no longer a one-way bet,” said Jens Nordvig, managing director of currency research at Nomura Holdings Inc. in New York.

While analysts have revised down fourth-quarter forecasts for the Intercontinental Exchange’s U.S. Dollar Index, they’re still calling for gains this year. The median forecast is for the index to rise this year at 99.6, compared with a closing level of 96.3 on Friday, according to a Bloomberg survey.