US Dollar Forecast: DXY Gains as Inflation Pressures May Delay Fed Easing

U.S. Dollar Rises as PCE Report Fuels Fed Rate Uncertainty

The U.S. dollar edged higher on Friday following the latest Personal Consumption Expenditures (PCE) report, which reinforced expectations that the Federal Reserve may delay its first interest rate cut. Treasury yields also moved higher as investors reacted to the data, which showed inflation accelerating on an annual basis.

The U.S. Dollar Index (DXY) traded at 108.295, up 0.11%, reaching a session high of 108.366. Traders weighed the implications of the PCE data, as well as comments from Fed officials, for the central bank’s policy path in the coming months.

PCE Inflation Shows Persistent Pressures

The PCE price index, the Fed’s preferred inflation gauge, rose 0.3% in December from the previous month and 2.6% on an annual basis. While these figures matched economist expectations, the yearly increase was higher than November’s 2.4%, suggesting inflation is not cooling as quickly as the Fed would like.

Core PCE, which strips out volatile food and energy prices, climbed 0.2% month-over-month and 2.8% from a year earlier. This keeps inflation well above the Fed’s 2% target and complicates expectations for rate cuts in the near term.

Treasury Yields Tick Higher on Rate Outlook

Following the inflation report, Treasury yields inched higher, reflecting investor concerns that the Fed may hold rates steady longer than previously anticipated. The 10-year yield rose by 2.1 basis points to 4.533%, while the 2-year yield climbed 2 basis points to 4.216%.

On Thursday, yields had moved lower after a weaker-than-expected U.S. GDP report showed the economy grew at an annualized rate of 2.3% in the fourth quarter, below the 2.5% forecast. However, Friday’s PCE data renewed worries about inflation persistence, reversing some of that decline.

Fed Signals Patience Despite Market Pressure

The Fed left interest rates unchanged at its first meeting of the year, maintaining a target range of 4.25%-4.50%. Chair Jerome Powell emphasized that the central bank needs to see “real progress on inflation or some weakness in the labor market” before considering rate cuts.

Fed Governor Michelle Bowman also made hawkish remarks on Friday, reinforcing the view that the Fed will not rush into easing policy. This added to market uncertainty and provided further support for the dollar.

Traders Adjust Rate Cut Bets as Dollar Gains Support

Following the inflation report and Fed commentary, traders continued to price in a high likelihood that the first rate cut will not come until June. Fed funds futures reflected about a 70% chance that the short-term borrowing rate will be 4.25% or lower after the June meeting.

A second rate cut is now expected no sooner than October. This repricing of expectations has helped underpin the U.S. dollar, with DXY holding firm above 108.

Market Forecast: Dollar Strength Hinges on Fed Policy Signals

With inflation showing some persistence and Fed officials maintaining a cautious stance, the U.S. dollar is likely to remain supported in the near term. Treasury yields may continue to fluctuate based on incoming economic data, but without clearer signs of disinflation, rate-cut bets could be pushed further out.

If upcoming employment and inflation reports reinforce the Fed’s cautious approach, the dollar could extend its gains, while any significant cooling in price pressures might revive expectations for earlier rate cuts. For now, traders will closely monitor Fed communications and key economic releases for further direction.

More Information in our Economic Calendar.