Dollar strengthens as traders anticipate aggressive rate rises

The dollar surged against other major currencies on Monday as traders weighed the prospect of aggressive interest rate rises in the US and intensifying recession risk in Europe.

The dollar index, which tracks the US currency against six others and has a large euro weighting, rose 0.7 per cent to around its highest point since 2002. That ascent helped to push the euro closer to parity with the greenback, with Europe’s common currency dropping as much as 0.9 per cent to $1.0094 — closing in on a level not seen for nearly two decades.

The dollar also hit a fresh 24-year high against the Japanese yen, buying ¥137.27.

Market sentiment in recent weeks has swung between a recognition that central banks need to raise interest rates aggressively to combat soaring inflation and a more forward-looking view that excessive monetary tightening may cause a global economic slowdown.

Both narratives have firmed investors’ bullishness towards the dollar, particularly because recession risks are seen as higher in Europe. The European Central Bank has followed the US Federal Reserve into tightening monetary policy, but is expected to remain as dovish as possible to counter economic shocks from Russia’s invasion of Ukraine.

“We’re expecting a recession earlier in Europe” said Sonja Laud, chief investment officer at Legal & General Investment Management. “The US is an energy exporter, Europe is an importer and in the current energy price environment that makes all the difference.”

As Russia shut its Nord Stream 1 gas pipeline for 10 days of scheduled maintenance on Monday, ING strategists noted that “many fear Russia may take the chance to halt or considerably trim its exports” in “a severe blow to the region’s economic outlook”.

Futures linked to TTF, Europe’s wholesale gas contract, edged 0.1 per cent higher to €170 per megawatt hour on Monday, remaining more than double their level in early June.

Following unexpectedly strong jobs data for June, analysts expect the Fed to raise rates by as much as 0.75 percentage points at its July meeting to tame inflation, following a similar move last month.

Futures markets tip the US funds rate to peak at 3.54 per cent next March, while the ECB is expected to nudge borrowing costs gradually higher, from minus 0.5 per cent currently to just over 1 per cent by February.

The Bank of Japan, meanwhile, has defied the global trend towards tighter monetary policy. On Monday, BoJ governor Haruhiko Kuroda warned of “very high uncertainty” for the domestic economy in a strong signal that the central bank will retain its easing stance.

In stock markets, the Stoxx Europe 600 index lost 0.3 per cent and Germany’s Xetra Dax dropped 0.8 per cent, following sharp falls in China driven by new Covid-19 restrictions.

Futures markets indicated that Wall Street’s S&P 500 share index, which rose last week following its worst first half of the year for more than five decades, would lose 0.5 per cent at the New York opening bell.

Hong Kong’s Hang Seng share index shed 2.8 per cent and mainland China’s CSI 300 dropped 1.7 per cent after cities across China reimposed coronavirus restrictions to battle the highly contagious BA.5 Omicron subvariant.

The yield on the 10-year German Bund, which falls as the price of the benchmark eurozone debt instrument rises, fell 0.05 percentage points to 1.29 per cent.

The yield on the 10-year US Treasury bond, which underpins debt pricing worldwide, traded 0.04 percentage points lower at 3.06 per cent.