Dollar consolidates gains as U.S. yield curve continues to flatten

The U.S. dollar consolidated gains on Monday after hitting a 1-1/2 year high on Friday as the Treasury yield curve extended a three-week flattening streak following hawkish comments by a Federal Reserve official.

With the Fed clearly signalling its intent to raise interest rates as early as March after its meeting last week, money markets and major Wall Street banks are now expecting as many as five rate hikes this year.

But some investors expect policymakers are preparing the markets for a faster pace of rate increases this year to check inflationary pressures especially after last week’s strong data.

The Fed could supersize an interest rate increase to half a percentage point if inflation remains stubbornly high, Atlanta Fed President Raphael Bostic told the Financial Times in an interview.

“Bostic is a non-FOMC voter so I would not get too carried away by his comments but you could say he is testing the market waters,” said Kenneth Broux, a strategist at Societe Generale (PA:SOGN).

“The debate of 25 bps (basis points) or 50 bps in March explains why the dollar should keep doing well and stocks could remain shaky in the short-term.”

Versus a basket of its rivals, the greenback rebounded off early lows to steady at 97.13 after rising to a mid-2020 high at 97.44 on Friday. The dollar’s 1.6% jump last week was the biggest weekly rise since mid 2021. Long dollar positions remained near their highest levels this year.

A quicker pace of rate hikes is also seen as dampening future growth expectations, a scenario that is playing out in the bond markets where spreads between two and ten-year U.S. Treasury yields fell below 59 bps for the first time since early November in a phenomenon known as “bear-flattening.” [US/]

Market expectations of as many as five rate hikes this year “reflects the growing belief that the Fed is behind the curve in fighting upside inflation risks and will need to deliver more front-loaded tightening,” Mizuho strategists said in a note.

U.S. data on Friday showed the core personal consumption expenditures (PCE) price index, the Fed’s preferred inflation gauge, rose 4.9% year-on-year, the biggest increase in 39 years.

Hedge fund positioning in currency markets also reflected a broadly consolidative trend with net dollar long positions edging higher but holding below recent highs.

The Australian dollar was among the early gainers versus the greenback with the Aussie up more than 0.7% at $0.7048 before a central bank policy meeting on Tuesday.

The Bank of England also holds its meeting on Thursday, with a Reuters poll of economists predicting a second rate hike in less than two months after UK inflation jumped to its highest in nearly 30 years.

The European Central Bank also has a policy meeting on Thursday. While no policy change is expected, analysts are starting to warn that approaching rate hikes from the Fed will shrink the ECB’s window for action.

In cryptocurrencies, bitcoin was holding above $37,000 after a quiet weekend for the digital asset.