US Dollar Strengthens as Crude Oil Surges and Bond Yields Climb to Multi-Year Highs

The US dollar index (DXY00) climbed by 0.14% on Tuesday, staying close to Monday’s one-and-a-half-week high. A sharp 4% surge in WTI crude oil prices on Tuesday bolstered inflation expectations, potentially encouraging the Federal Reserve to tighten monetary policy and supporting the greenback. Additionally, the 10-year Treasury note yield rose to a 19-year high of 5.04%, enhancing the dollar’s interest rate differential advantage. Expectations of a 25 basis point interest rate hike by the Federal Reserve at the upcoming Tuesday-Wednesday FOMC meeting further underpinned the dollar. However, the dollar pulled back slightly from its peak after the September Empire State manufacturing survey showed a weaker-than-expected reading.

The survey revealed that the Empire State manufacturing index of general business conditions dropped by 13.0 points to 7.6, significantly below the consensus expectation of 15.0.

Market participants are currently pricing in a 96% probability of a 25 basis point rate hike by the Federal Reserve at the upcoming FOMC meeting.

The EUR/USD pair fell by 0.06% on Tuesday, hovering just above Monday’s one-month low. The dollar’s broad strength exerted downward pressure on the euro, while a 4% spike in crude oil prices acted as a headwind for the Eurozone economy, which relies heavily on imported energy.

The euro managed to find some support following the release of the German ZEW survey, which showed that expectations for economic growth rose to a seven-month high in September. Furthermore, the 10-year German Bund yield climbed to a 17-year high of 3.57%, bolstering the euro’s interest rate differential.

Specifically, the German ZEW index of economic expectations rose by 0.5 points to a seven-month high of 34.7, although this fell short of the expected reading of 40.0.

Markets are currently discounting a 56% probability of a 25 basis point rate hike by the European Central Bank at its next policy meeting on October 29.

The USD/JPY pair rose by 0.48% on Tuesday, with the yen sliding to a one-week low against the dollar. The Japanese currency faced selling pressure following reports that the government is considering a new defense spending target of 3.5% of GDP. This potential increase in spending could boost government debt issuance to fund the initiative, bearing negatively on the yen. Additionally, the 4% surge in crude oil prices is bearish for the Japanese economy and the yen, as Japan imports over 90% of its energy. Higher US Treasury yields on Tuesday also weighed on the yen.

Downside losses for the yen were limited after the July tertiary industry index rose more than expected. In addition, the sharp jump in the 10-year Japanese Government Bond (JGB) yield to a 30-year high of 3.04% helped strengthen the yen’s interest rate differentials.

The Japanese tertiary industry index increased by 0.4% month-on-month in July, outperforming the consensus expectation of 0.3%.

The yen also benefited from carryover support from the previous week, when the Japanese health minister—who oversees the Government Pension Investment Fund (GPIF), which manages $2.1 trillion in assets—indicated that the fund is still considering a review of its asset allocation. The recent surge in the 10-year JGB yield to a 30-year high has fueled speculation that the GPIF might increase its allocation to Japanese government bonds, which would provide further support for the yen.

Looking ahead, the yen is supported by strong expectations of a Bank of Japan (BOJ) rate increase this week. Markets are pricing in a 100% chance of a 25 basis point rate hike at Friday’s policy meeting. The Japanese government favors such a hike to support the yen and mitigate inflationary pressures stemming from currency weakness. Finally, the yen continues to draw support from the recent coordinated US-Japan intervention, with fears of further intervention persisting if the yen remains weak.

December COMEX gold futures (GCZ26) closed down 19.10 points, or 0.44%, on Tuesday, while December COMEX silver futures (SIZ26) fell by 0.282 points, also a decline of 0.44%.

Precious metals prices finished lower on Tuesday as a stronger US dollar and soaring global bond yields weighed on the market. The 10-year Treasury yield hit a 19-year high, the 10-year German Bund yield reached a 17-year high, and the Japanese 10-year JGB yield climbed to a 30-year high, all of which are negative factors for non-interest-bearing precious metals. Furthermore, the 4% surge in crude oil prices to a 3.75-month high has raised inflation expectations, potentially prompting global central banks to tighten monetary policy—a bearish outlook for precious metals. Expectations of a 25 basis point rate hike by the Federal Reserve this week and a similar move by the Bank of Japan on Friday further dampened sentiment.

Losses in silver prices were somewhat limited on Tuesday, supported by signs of stronger industrial metals demand in China following a report that the country’s August industrial production rose by 5.2% year-on-year, exceeding the expected 4.8% increase.

Recent fund support remains a bullish driver for precious metals, with long holdings in gold exchange-traded funds (ETFs) climbing to a 6.25-month high on Tuesday. Similarly, long holdings in silver ETFs rose to a 5.5-month high on August 25.

Strong central bank demand continues to support gold prices. This follows news that gold bullion held in the People’s Bank of China (PBOC) reserves increased by 650,000 ounces to 76.73 million troy ounces in August, marking the largest monthly increase in three years and the twenty-second consecutive month of accumulation.

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