The U.S. dollar continued to strengthen on Friday and was on track for its biggest weekly gain in more than two months. The main driver came from rising energy prices, prolonged shipping disruptions, and growing inflationary pressure, which led markets to raise expectations that the Federal Reserve could hike interest rates again this year.

Dollar Strengthens on Higher Rate Expectations

The Dollar Index climbed to a two-week high of around 98.98. For the week, the index was set to rise by more than 1%, marking its strongest weekly increase since early March.

The dollar’s recovery came as U.S. economic data continued to show resilience. April retail sales increased further, while weekly initial jobless claims pointed to stability in the labor market. These signals have led investors to believe that the Fed may not be in a hurry to ease monetary policy.

According to the CME FedWatch Tool, markets are now pricing in a probability of just over 44% that the Fed could raise rates in December, up sharply from 22.5% a week earlier. In other words, market expectations are shifting from hopes of imminent rate cuts to the possibility that high interest rates may stay for longer.

Energy Prices and Middle East Tensions Add to Inflation Risks

One of the key factors supporting the dollar is the concern that inflation could rise again due to higher energy prices. The ongoing conflict in the Middle East, particularly Iran’s disruption of activity around the Strait of Hormuz, has raised concerns about global oil supply.

Higher energy prices could increase transportation, production, and consumer costs, allowing inflationary pressure to spread more broadly across the economy. This is why some analysts have begun revising their U.S. CPI forecasts for 2026 higher.

Alvin Liew, senior economist at UOB, noted that although U.S. domestic demand is being weighed down by rising energy costs, inflation risks remain tilted to the upside. UOB now expects the Fed to maintain an extended pause for the remainder of 2026 before resuming easing in 2027.

Markets Watch the Trump-Xi Meeting

Alongside the interest rate story, investors are closely watching the second day of talks between U.S. President Donald Trump and Chinese President Xi Jinping. Key areas of focus include efforts to reopen the Strait of Hormuz and the possibility that China could buy more American oil to reduce its dependence on Middle Eastern supplies.

However, market reaction has remained cautious as investors wait for more details on trade, business access, and specific policy arrangements. The offshore yuan stayed near its highest level in more than three years, trading around 6.7874 per dollar.

Major Currencies Come Under Pressure

The dollar’s rally put pressure on several major currencies. The Japanese yen weakened past the 158 level against the dollar, keeping traders alert to the possibility of further intervention from Tokyo.

The euro edged lower to $1.1662 and was also heading for a weekly decline of more than 1%. The British pound fell to a one-month low of around $1.3385 after the resignation of British Health Minister Wes Streeting deepened the political crisis in the UK.

Meanwhile, the Australian dollar and New Zealand dollar also eased slightly under pressure from the stronger greenback.

Conclusion

The U.S. dollar is currently being supported by three main factors: expectations that the Federal Reserve may maintain a tougher monetary policy stance, renewed inflation risks driven by higher energy prices, and prolonged geopolitical uncertainty in the Middle East.

In the short term, if U.S. economic data remains stable and inflationary pressure does not ease, the dollar may continue to hold an advantage over many major currencies. However, markets will keep a close watch on signals from the Fed, oil price movements, and concrete outcomes from U.S.-China talks before confirming the next major trend.

Source: Reuters

Disclaimer: This content is for market research and informational purposes only and does not constitute investment advice.