• Dollar index hits highest since late July as Fed signals more hikes.
  • Markets price 53% chance of an October move after last week’s first increase in three years.
  • ING (ING) sees both Fed and ECB tightening again, but an October move appears more likely from the Fed.

Dollar Rallies on Hawkish Fed

The dollar climbed to its highest level since July on Monday, as Federal Reserve officials signaled that additional rate hikes may be needed to combat persistent inflation. The dollar index, which tracks the greenback against a basket of major currencies, rose to around 100.3–100.4, marking a 1.42% appreciation over the past month. The rally follows the Fed’s September 16 decision to raise the federal-funds target range by 25 basis points to 3.75%–4.00%, its first increase since 2023. The move was unanimous.

Market Pricing Shifts

In the immediate aftermath of the meeting, traders priced in a 53% probability of another quarter-point hike at the October FOMC meeting, according to market-implied odds. The probability of at least one further hike by December is considerably higher. “The Fed’s projections imply a median end-2026 policy rate of roughly 4.1%, consistent with one additional quarter-point hike,” noted analysts at ING. The bank expects both the Fed and the European Central Bank to tighten again, but sees an October move as more likely from the Fed.

The Fed’s updated projections raised its 2026 outlook for PCE inflation to 3.7% and core PCE inflation to 3.4%. It also projected stronger growth and lower unemployment than in June, suggesting policymakers are less confident that inflation will fall quickly without further restraint. Sixteen of 18 participants anticipated at least one more increase this year; four saw scope for two.

Economic Crosscurrents

Higher expected U.S. policy rates tend to support the dollar because dollar assets offer comparatively stronger expected returns. They also lift borrowing costs across mortgages, business loans, consumer credit, and corporate refinancing. The stronger dollar has mixed effects: it can lower the domestic-currency cost of imported goods and commodities for U.S. buyers, but it makes U.S. exports less price-competitive and increases the local-currency burden of dollar-denominated debt abroad.

Markets have responded across asset classes: higher Treasury yields and a firmer dollar generally pressure rate-sensitive equities, gold, emerging-market assets, and housing. These effects were visible in the initial market reaction to the Fed decision.

The European side is important because exchange rates depend on relative monetary policy. The ECB also raised rates in September, taking its deposit rate to 2.5%, amid euro-area inflation that accelerated to 3.3% in August. Energy inflation rose to 14.3%, while core measures were softer, illustrating the difficult trade-off between an energy-driven price shock and weakening underlying inflation momentum.

Political and International Context

Energy has become a major policy transmission channel. ECB commentary linked continuing inflation pressure to higher energy prices associated with the U.S.–Iran conflict, while its staff projections still put euro-area headline inflation at 3.0% for 2026, 2.5% in 2027, and 2.1% in 2028.

For the United States, the timing is politically sensitive: the October FOMC meeting falls close to the midterm elections. Monetary-policy decisions are formally independent of electoral politics, but some analysts believe the proximity may make December more plausible than October if policymakers can wait for more inflation data without damaging credibility. ING specifically cited the meeting’s timing among the reasons it views December as more likely.

Internationally, the main implication is a potential widening or persistence of interest-rate differentials. Emerging-market governments and firms face higher servicing costs on dollar debt and possible capital outflows. U.S. exporters may see a headwind from a stronger dollar, while importers and consumers get some relief on import prices.

Historical Background

The September move ended a long pause: it was the Fed’s first rate increase since July 2023. The previous tightening cycle was designed to curb the post-pandemic inflation surge; this latest action signals that policymakers see a renewed risk that inflation may remain above target for longer than previously expected. There is a notable contrast with typical late-cycle policy paths. Rather than moving toward cuts after inflation receded, the Fed’s September projections pointed to no reduction in 2027 and only later easing, implying a more durable period of restrictive policy.

A useful precedent is the 2022–23 global tightening cycle: when the Fed tightened faster or more aggressively than peers, the dollar strengthened, global financing conditions tightened, and markets became highly sensitive to every inflation release and central-bank communication. The present episode could recreate some of those dynamics, though from a lower and more gradual projected rate path.

Outlook and Related Developments

Near term, the next U.S. inflation, labor-market, spending, and energy-price data will determine whether the October probability rises materially above its current near-even level. A stronger inflation reading, continued resilience in economic activity, or higher oil prices would tend to favor an October hike and support the dollar. Conversely, clear disinflation or weakening employment could shift expectations toward December or no additional move.

Goldman Sachs (GS) moved to an October-hike forecast after the Fed’s hawkish signal. ING’s current central case is different: one more increase by both the Fed and ECB, but in December, followed by an extended pause. ING retains a year-end EUR/USD target of 1.160, despite seeing near-term downside risk for the euro. It argues that a return toward June’s 1.1320–1.1330 EUR/USD lows would become more plausible if Brent crude approached $110 and markets increased the probability of an October Fed hike.

The key uncertainty is that the Fed and ECB are responding partly to energy-related inflation—a type of inflation that rate hikes cannot directly produce more oil or fuel to solve. More tightening could anchor expectations and contain demand, but it also risks slowing growth and raising financing stress. The dollar’s rally will therefore remain closely tied not only to Fed communication, but also to energy markets, geopolitical developments, and whether incoming inflation data validate the central banks’ more hawkish stance.