The US dollar pared some of its post-payroll advance, as talk of a US-Iran breakthrough pushed Brent crude to a three-month low. Even so, expectations for the greenback to grind higher in the near term rest on resilient US activity, which is described as strong in both absolute and relative terms, offsetting the currency drag from easing geopolitical tensions.
Attention is turning to a Federal Reserve hold that is framed as hawkish, after the centre of gravity on the FOMC moved from an easing stance to a neutral bias as labour demand improved and inflation firmed. Markets are watching whether guidance aligns with Fed funds futures that imply a 25bps hike by year end, while the dot plot is expected to pivot from signalling a 25bps cut in 2026 to a median projection consistent with a 25bps hike. Separate references were made to Kevin Warsh risks affecting the dollar’s outlook.
Resilient US Economy and Dollar Outlook
We are positioning for the US Dollar to edge higher in the coming weeks. The American economy is proving resilient, as shown by the recent May jobs report which added a solid 265,000 positions and kept the unemployment rate at a low 3.7%. This fundamental strength should outweigh any temporary drag on the dollar from easing geopolitical tensions that have pushed oil prices below $75 a barrel.
The Federal Reserve’s stance is shifting from neutral to hawkish, largely because inflation is not cooling as quickly as hoped. With core CPI holding firm at 3.5% year-over-year, the central bank has a clear reason to signal that interest rates will remain elevated. This week’s FOMC meeting will be critical, and we expect their commentary to be firm.
Strategies and Market Positioning
For derivative traders, this outlook suggests buying call options on the US Dollar Index (DXY) or on ETFs like UUP. The market is already anticipating this hawkishness, with Fed funds futures currently pricing in over a 70% probability of a rate hike by the December 2026 meeting. We see value in positions that profit from a stronger dollar, particularly against the Euro and Yen.
The key signal to watch will be the Fed’s dot plot, which we expect will shift from implying a cut to showing a median projection for one 25-basis-point hike this year. This scenario is similar to the 2022 tightening cycle, where hawkish forward guidance consistently led to dollar appreciation. Therefore, consider bull call spreads on USD/JPY to capitalize on this expected move while defining risk.
