US Dollar outlook: Hawkish Fed repricing strengthens the bull case

• Hawkish Fed pricing continues lifting front-end Treasury yields
• Haven demand adds another bullish tailwind
• Little on US calendar this week to derail bull case

The US Dollar Index has broken out, fuelled by another sharp increase in hawkish Fed pricing ahead of next week’s FOMC meeting. With energy prices continuing to ratchet higher on the back of escalating geopolitical tensions in the Middle East, the fundamental backdrop is creating powerful tailwinds that reinforce the bullish technical picture.

Data backs DXY breakout

Source: TradingView

The correlation matrix below reinforces that message. Over the past five trading days, the DXY has exhibited an almost perfect positive correlation (0.99) with Fed pricing one year out, reflecting the continued hawkish repricing of the expected path for the Fed funds rate. The relationship extends across the Treasury curve, with correlations of 0.86 and 0.89 with US two and 10-year Treasury yields respectively.

Source: TradingView

Looking at the same relationship through another lens produces a similar result. The DXY has exhibited an almost perfect inverse correlation (-0.99) with US two-year Treasury note futures over the same period, reflecting the simple relationship that falling Treasury futures equate to higher yields.

Geopolitics add another tailwind

There is also evidence the dollar is attracting renewed safe-haven demand. The strengthening positive relationship with the MOVE Index, which measures expected volatility in the US Treasury market, coincides with a broader pickup in volatility across sovereign debt markets, reflecting a rise in market uncertainty that appears to be boosting demand for the greenback.

That may reflect renewed concerns about the UK's fiscal outlook following the appointment of a new Prime Minister with a history of favouring expansionary policies, which have fuelled volatility in gilt markets. Renewed fighting in the Middle East and higher energy prices are also increasing economic risks for major energy importers such as Europe and Japan.

Dollar bulls regain technical control

Source: TradingView

While the DXY isn't a readily traded instrument, it provides a useful guide as to where directional risk may lie for the broader US dollar.

Following softer-than-expected CPI and PPI reports last week, the index broke the uptrend that had been in place since early May. However, the technical picture has improved markedly over the past four sessions. An initial piercing pattern on the daily chart has been followed by sustained buying pressure, culminating in a break above the downtrend that's been in place since the June 24 high.

Longer-term trend signals remain constructive. The DXY continues to trade above its 50, 100 and 200-day simple moving averages, all of which retain a positive slope. The downtrend in RSI (14) that's been in place since late June has also been broken. While the indicator has yet to register a higher high, a reading around 58 suggests momentum is beginning to tilt back in favour of the bulls. MACD also remains in positive territory and is converging on its signal line, hinting that a bullish momentum crossover may not be far away.

If buying interest continues, the first upside level to watch is 101.30, where the price stalled several times earlier this month. Above there, attention shifts to 101.50, followed by the June 24 high of 101.80. A break there would bring the May 2025 swing high at 102.00 into view.

On the downside, the former downtrend becomes the first area to watch on any pullback to see whether resistance turns into support. Last week's buying interest below 100.50 also stands out, ahead of more important support near 100.31, the former June 11 resistance level.

Treasury futures reinforce message

Source: TradingView

While the correlation matrix highlighted the strong relationship between the DXY and US two-year Treasury yields, looking at Treasury note futures provides another perspective on the same story. Because futures prices move inversely to yields, continued weakness in two-year note futures reinforces the message that markets continue to price a more hawkish path for Fed policy.

The broader trend in US two-year Treasury note futures remains firmly bearish. Over the past six weeks, futures have carved out a clear sequence of lower highs and lower lows, signalling markets continue to push front-end Treasury yields higher.

Following last week's softer inflation reports, futures staged a brief recovery but were rejected at the confluence of the 50-day simple moving average and the prevailing downtrend. Sellers have since regained control, putting the recent swing low back in focus.

A break beneath that level would reinforce the prevailing downtrend and expose the next significant support near 102.16. That's an important area because buyers repeatedly stepped in whenever futures tested, or briefly traded through, that level during late 2024 and early 2025. Whether demand re-emerges there could prove pivotal for the next move in front-end Treasury yields. If not, it would reinforce the broader case for further US dollar strength.

What could derail the bull case?

For now, there's little on the horizon to suggest that relationship is about to change.

There's nothing on the US calendar this week to shift the fundamental or technical picture. With the Fed now in its pre-FOMC blackout period and no top-tier US data scheduled before next week's policy decision, markets are unlikely to receive much in the way of domestic catalysts.

That leaves external developments as the most likely source of volatility. A meaningful de-escalation in the Middle East that eases pressure on energy prices could lessen tailwinds powering dollar upside. Elsewhere, with USD/JPY trading at fresh multi-decade highs, the risk of intervention from Japanese authorities on behalf of the Ministry of Finance cannot be ignored if yen weakness accelerates further.

Until then, the combination of hawkish Fed pricing, higher front-end Treasury yields and a supportive technical backdrop suggests the path of least resistance for the big dollar remains higher.