The US dollar extended its gains for a sixth consecutive session, benefiting from the Federal Reserve’s decision to raise interest rates for the first time since July 2023, while stronger economic data and rising Treasury yields reinforced expectations that monetary policy will remain restrictive. The US Dollar Index climbed to 100.2 points after the Federal Open Market Committee unanimously raised the federal funds target range to 3.75% to 4.00% from 3.50% to 3.75%.
The decision itself did not surprise markets, but attention quickly shifted to the updated dot plot, which showed that the majority of committee members still see room for another rate increase this year, while some expect two additional increases. The latest Summary of Economic Projections also showed a median policy rate of 4.1% by the end of 2026, helping keep the dollar supported and strengthening the view that the tightening cycle may not end with the latest move.
The decision comes at a time when the Federal Reserve is dealing with a difficult combination of resilient economic activity and persistent price pressures. The Personal Consumption Expenditures Price Index rose 3.7% year on year, remaining above the Federal Reserve’s 2% target for the sixty fifth consecutive month. The Consumer Price Index also rose 3.4% in August. The inflation outlook has become more complicated as oil prices climbed above 100 dollars per barrel due to escalating tensions in the Middle East, increasing the risk that inflation could move higher in the coming months.
Federal Reserve Chair Kevin Warsh said summer inflation readings had not provided sufficient evidence of a meaningful slowdown in price pressures and that current financial conditions were still not restrictive enough to bring inflation sustainably back toward the 2% target. His comments reflected a broader view within the committee that ending monetary tightening too early could carry greater risks than keeping interest rates elevated for a longer period.
The bond market has also played a major role in shaping expectations for monetary policy in recent weeks. Since the July Federal Reserve meeting, longer maturity US Treasuries have faced a strong wave of selling that pushed the ten year Treasury yield to its highest level since April 2007, while the thirty year yield climbed to its highest level in more than two decades. The pressure has not been driven by inflation and oil prices alone. Investors have also become increasingly concerned about the widening US fiscal deficit, rising government debt, and the scale of spending on artificial intelligence infrastructure.
As the gap between the federal funds rate and longer maturity Treasury yields has widened, markets have become increasingly convinced that the Federal Reserve needs to maintain a restrictive policy stance to prevent inflation expectations from becoming unanchored. The main debate is therefore no longer focused solely on the latest rate increase, but on whether it marks the beginning of a new phase of tightening or a limited move that will be followed by an extended period of unchanged rates.
In foreign exchange markets, the dollar benefited from this shift in expectations, while the British pound came under pressure despite higher inflation in the United Kingdom. Sterling fell to 1.3347 dollars after UK consumer price inflation accelerated to 3.1% year on year in August from 2.9% in July, while monthly inflation increased by 0.5%. Transport and fuel prices made the largest contribution to the increase, reflecting the impact of higher global energy prices, while core inflation remained unchanged at 2.6%.
These figures have made the Bank of England’s policy challenge more difficult. Markets still broadly expect interest rates to remain unchanged, but the probability of a 25 basis point increase has risen to around one in three, while another move before the end of the year remains possible. Support for sterling will therefore depend not only on inflation data but also on how willing the Bank of England is to adopt a more restrictive stance in response to persistent price pressures.
Citi estimates that an unchanged rate decision accompanied by a restrictive message from the Bank of England could provide some near term support for sterling, particularly because markets currently price in only limited additional tightening. However, that support may prove temporary as attention returns to the United Kingdom’s fiscal position and the October 28 budget. Weakness in the UK government bond market could reduce the government’s available fiscal room, while uncertainty surrounding domestic political commitments may add another layer of caution for investors.
The outlook for the foreign exchange market in the coming period will therefore remain tied to three main factors: the continued strength of the US dollar supported by Federal Reserve policy and Treasury yields, the Bank of England’s ability to control inflation without placing excessive pressure on economic growth, and the development of inflationary pressures linked to oil prices and geopolitical tensions.
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