- Following the tariffs, investors also expected the US dollar to strengthen.
- The Bank of England does not rule out an increase in the repo rate.
The US dollar has recorded its best two-day rally since the start of the armed conflict in the Middle East. At the time, it rose thanks to strong demand for safe haven assets and its role as a net energy exporter currency. It briefly surpassed 101, reaching its highest level in the last 13 months. This time, the market is not being driven by a shock but by a gradual reassessment of the monetary policy outlook over the past month. This reassessment, stemming from a shift in market views on the Fed's future, has gained new momentum following hawkish comments from Federal Reserve Chairman Kevin Warsh.
Just a week ago, the probability of at least two rate hikes in 2026 stood at 17%; it has now increased to 53%. This has driven yields to their highest levels since February 2025, lifting the dollar index to its highest level since May 2025.
At the time, a month after the tariffs were announced, it was believed that they would have a significant pro-inflationary effect, forcing the Federal Reserve to raise rates. In fact, the central bank cut rates in September, October and December last year, causing the dollar to fall. Expectations that this cycle would continue this year led to a sell-off in December and January.
There is also a current narrative that the Federal Reserve's intention to bring inflation back to its 2% target will force it to raise rates. However, Capital Economics believes that US consumer prices already peaked in May at 4.2% year-on-year. As oil and gasoline prices fall, the slowdown. Therefore, the futures market probably overestimates the probability of a tightening of monetary policy, and a reversal of this assessment will weaken the US currency.
Meanwhile, as expected, they kept the repo rate at 3.75%. Maximum inflation forecasts were revised downwards from 3.6% to 3.25%. For the Bank of England, the end of the conflict in the Middle East has reduced the risk of accelerating consumer price inflation, but has not eliminated it. This prevents the central bank from ruling out a tightening of monetary policy.
The strength of the US dollar has reached 40-year highs. The market has ignored comments from Japan's Finance Minister Satsuki Katayama that the government is prepared to take bold and decisive action. Clearly this is partly due to a strong dollar rather than a weak yen, but USDJPY is trading near or above several 40-year highs. Interventions have occurred at these levels on numerous occasions. Will Japan intervene now?
The FxPro Analyst Team
