The dollar climbed to a seven-week high on Thursday after the Federal Reserve raised interest rates and signaled that another increase could follow, bolstering its commitment to bringing inflation back under control even as U.S. President Donald Trump continues to demand lower borrowing costs.
The dollar index, which tracks the greenback against a basket of major currencies, reached 100.36, its highest level since July 31, before paring gains to trade 0.16% lower at 100.13.
The move followed the Fed’s decision on Wednesday to raise its benchmark interest rate by 25 basis points to a target range of 3.75% to 4%. The increase was the central bank’s first since July 2023 and came after a series of stronger-than-expected inflation readings and a sharp rise in Treasury yields.
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Fed Chair Kevin Warsh said inflation remained too high to justify leaving monetary policy unchanged.
“Inflation has been too high … for too long,” Warsh said at a news conference. “We must be confident that underlying inflation is moving to our objective clearly and at sufficient speed.”
The Fed’s updated projections also pointed to another increase this year. Sixteen of the 18 officials included in the dot plot expect at least one more hike, while four see the possibility of two additional increases.
That outlook has helped support the dollar by reinforcing expectations that U.S. interest rates will remain elevated for longer.
But a widening gap has emerged between policymakers’ projected path and financial markets’ expectations. While Fed officials currently project one additional increase in 2026 and no further hike in 2027, investors are pricing in more than one additional increase this year and roughly three more through the end of 2027.
The divergence leaves the dollar sensitive to incoming inflation and economic data, as well as to any further confrontation between the White House and the central bank.
“The greatest danger for the U.S. dollar lies in the U.S. president increasing pressure on the Fed again in the coming weeks, which could lead to renewed doubts about the Fed’s independence,” said Michael Pfister, a strategist at Commerzbank.
“However, the Fed itself did its best yesterday to dispel these doubts.”
Trump has repeatedly called for substantially lower interest rates. In a social media post, he said U.S. rates should be “1 per cent, or less,” arguing that the country is “the best credit in the world.”
He also criticized the Fed’s board on Wednesday, describing it as “very hostile” and “very political” and saying it was “doing the wrong thing.”
However, the market’s response is seen as an indication that the Fed’s latest decision has, at least temporarily, reinforced confidence that policymakers remain focused on inflation.
Oil Reversal Takes Pressure Off the Dollar
The dollar subsequently gave up some of its gains as oil prices extended their decline on reports that Saudi Arabia was offering additional crude cargoes through Oman, reducing fears of a prolonged supply disruption.
Energy prices have become an important driver of currency markets as the conflict in the Middle East threatens global oil supplies.
Higher oil prices generally support the dollar because the United States is less dependent on imported energy than many other major economies. A sustained energy shock can therefore put greater pressure on currencies such as the euro and yen, potentially increasing demand for dollar-denominated assets.
The latest decline in oil prices has weakened that support.
The move also followed comments from Trump that he hoped an end to the U.S.-Israeli war on Iran was near. A separate media report said he was expected to meet Gulf leaders on the sidelines of the United Nations General Assembly next week to discuss the conflict.
The euro rose 0.14% to $1.1481 after earlier falling to $1.1456, its lowest level in seven weeks. Sterling gained 0.10% to $1.3395 ahead of the Bank of England’s policy decision.
Meanwhile, Treasury yields edged lower after their recent surge.
The 10-year Treasury yield was down two basis points at 4.986%, while the 30-year yield fell one basis point to 5.333%. The two-year yield, which is particularly sensitive to expectations for monetary policy, declined one basis point to 4.715%.
The retreat came after the 10-year yield had reached its highest level since 2007 as investors adjusted to the prospect of higher U.S. rates.
Bob Edwards, chief investment officer at Edwards Asset Management, said the largest moves in the bond market may now have passed.
“There is now a good opportunity for investors after this big move to lock-in these elevated yields,” Edwards said.
He expects another Fed increase, if one occurs, to come at the December meeting rather than October, arguing that a rate decision immediately before the U.S. midterm elections could attract questions about the central bank’s political independence.
Yen and BOJ in Focus
The next major monetary-policy test for currency markets comes from Japan, where the Bank of Japan is expected to raise its policy rate on Friday to a level not seen in 31 years.
Investors are watching for signals from BOJ Governor Kazuo Ueda about how quickly the central bank intends to continue tightening monetary policy.
The dollar fell 0.41% against the yen to 155.68.
Japan’s policymakers are also monitoring currency movements closely. Chief Cabinet Secretary Minoru Kihara said Japan would continue working closely with the United States to maintain orderly yen movements.
The yen’s recent gains have been driven partly by growing expectations that the BOJ will continue raising rates. Speculative investors have shifted toward net-long yen positions, while Japanese retail investors have continued to hold short positions on expectations that the currency’s appreciation will not last.
Investors are also watching whether higher Japanese bond yields could encourage domestic institutions, including Japan’s Government Pension Investment Fund, to shift more money back into Japanese assets.
Such repatriation could affect global bond markets, particularly U.S. Treasuries, by reducing Japanese demand for overseas assets.
Mizuho expects Japan to continue normalizing monetary policy but at a slower pace than financial markets currently anticipate, with its policy rate reaching 1.75% by mid-2027.
The contrasting paths of the Fed and BOJ leave currency markets focused on the relative speed of monetary tightening. The Fed has resumed rate increases as inflation remains elevated, while Japan is moving further away from years of ultra-loose policy.