Rising US and global bond yields, combined with geopolitical risk and higher energy prices, have supported the US Dollar, while expectations of a Federal Reserve rate rise have also underpinned demand. The DXY is approaching its prior peak at 101.80, and a move above that level would add to upward momentum. In rates markets, the overnight index swap pricing implies roughly a 35% probability of a Fed hike next week, while Japan’s yields have continued to edge higher as the Bank of Japan proceeds with gradual policy normalisation.
Japan’s core-core nationwide CPI rose 1.7% year on year in June, and the adjusted measure that strips out temporary distortions stood at 2.7% in May. The latest US Treasury semi-annual report did not name any country for currency manipulation, but it referenced the yen’s undervaluation and argued that monetary policy normalisation would help anchor inflation expectations and curb excessive rate volatility. Separately, Axios reported that President Trump is considering a “massive attack” and was “close to making a decision”, raising concerns of escalation over the weekend, with the FOMC due on Wednesday.
Drivers And Trading Outlook For The US Dollar
We expect the US Dollar to continue its upward march in the coming weeks, driven by surging bond yields and escalating geopolitical tensions. As the US 10-year Treasury yield pushes back toward the 4.40% mark, the greenback is finding solid ground against major peers. Derivative traders should prepare for heightened volatility as energy markets react to potential military conflicts over the weekend.
The US Dollar Index (DXY) is currently testing a crucial resistance level at 101.80, which has held firm in recent months. We recommend buying short-term call options on the DXY to capitalize on a potential breakout above this barrier. Historical trends show that when the DXY breaks key resistance during periods of high geopolitical risk, the momentum often triggers rapid 2% to 3% rallies.
Japan And Monetary Policy Divergence
Despite Japan’s core-core inflation holding at 1.7% in June, the Bank of Japan’s slow pace of rate hikes is failing to protect the Yen. We see further room for USD/JPY to grind higher as the yield spread between the US and Japan remains exceptionally wide. Traders can exploit this by utilizing bull call spreads on USD/JPY to limit risk while capturing the steady upward drift.
With the next Federal Reserve meeting scheduled for July 29, the market is currently pricing in a 35% chance of an unexpected rate hike. If oil prices spike further due to weekend escalation fears, those rate hike odds will likely jump, driving the Dollar even higher. We suggest holding long Dollar positions through weekly options to hedge against a hawkish surprise from the Fed.
