U.S. Dollar Hits Highs as Oil Prices Surge

The Federal Reserve System is facing increased market pressure to raise interest rates as the U.S. dollar index climbed to a 1.5-week high. This surge was driven by a spike in WTI crude oil prices, which rose over 2% due to Middle East supply disruptions, including the closure of Saudi Arabia's East-West pipeline following threats from Houthi rebels. Consequently, the 10-year T-note yield reached a 19-year high of 5.04%, and markets priced in a 94% probability of a 25 basis point rate hike at the upcoming FOMC meeting.

Global markets reacted with volatility. Major U.S. stock indexes, including the S&P 500 and Dow Jones Industrial Average, hit six-week lows, weighed down by rising inflation expectations and a weak September Empire manufacturing survey. The euro fell to a one-month low, though it found some support from 17-year high German Bund yields and hawkish warnings from European Central Bank officials regarding further rate hikes.

The Japanese yen declined to a one-week low against the dollar. This weakness was compounded by rising oil costs, a downward revision of July industrial production, and reports that the Government of Japan is considering increasing its defense spending target to 3.5% of GDP. Amidst this volatility, the Government Pension Investment Fund of Japan began considering a review of its asset allocation toward Japanese government bonds.