Dollar keeps climbing as oil, US yields stay high; jobs data looms

By Alun John and Jiaxing Li

LONDON/HONG KONG, Sept 29 (Reuters) - The dollar rose on Tuesday, set to surpass several-month highs against major peers, as volatile oil prices and a rapid climb in Treasury yields lent support, while the Aussie struggled as traders saw a dovish message hidden inside a rate hike.

The euro dropped 0.24% to $1.1344, a three-month low, and a fall past its late June levels would take it to the lowest in well over a year, as the currency struggles in the face of a global energy shock and growing political risk in Europe.

But it is by no means unique. The pound fell 0.2% to $1.3228 again in sight of three-month lows hit last week, while the Swiss franc was also weaker at 0.8335 per dollar, its softest in four months. ,

Beyond domestic European reasons for weakness that are sending its currencies lower on the dollar, the greenback also is strengthening.

Elevated oil prices and a storming economy driving inflation fears have markets pricing in meaningful rate hikes by the Federal Reserve.

That in turn has sent Treasury yields higher across the curve, with the two-year yield, more important than longer dated peers for currencies, at its highest in two years and closing in on the symbolic 5% level. US/

Oil prices crept back up again on Tuesday, with Brent crude futures above $106 a barrel as markets doubted the success of renewed efforts to end the Iran war, after US President Donald Trump rejected Tehran's ceasefire proposal.

In a note, James Lord, global head of FX at Morgan Stanley, said the bank "now forecast USD strength through year-end and into 2027", from a prior expectation that the dollar would continue its descent into the year's second half.

It now forecasts the euro to fall to $1.10 by mid-2027, as widening rate differentials between the US and the rest of the world, robust US growth and European risk premium are expected to support the dollar.

"Elevated energy prices, robust US data, and a hawkish (Federal Reserve) reaction function has generated not just a rate hike but likely further hikes to come," the note said.

CENTRAL BANKS' TIGHTENING EYED

The dollar's next test is this week's key US data, including the PCE price index USPCEM=ECI on Wednesday and nonfarm payrolls USNFAR=ECI on Friday, to see if it supports the case for further Federal Reserve rate hikes.

Markets now see a more than 70% chance of a rate hike by the Federal Reserve at the end of October, up from 57% a week ago, according to CME Group's FedWatch tool.

But the Australian dollar's performance on Tuesday offers a warning of what can happen to currencies when expectations for rate hikes get ahead of themselves.

Australia's central bank raised its cash rate to a 15-year high of 4.60% on Tuesday in a unanimous decision, saying inflation was too high and it was prepared to hike further if needed.

But the Aussie plumbed its lowest in nearly two months, to stand down 0.44% at $0.6988, after a brief spike to a high of $0.7029 on the decision.

Australian yields fell, bringing the currency with them, after the Reserve Bank of Australia's governor told a press conference the board had considered a hold as well as a hike of 25 basis points.

"While this might sound unremarkable, markets may have been worried the discussion was between 25bp and 50bp," said analysts at RBC Capital Markets.

The Japanese yen was steady at 157.43 per dollar, having given back Monday's gains after top currency diplomat Atsushi Mimura said markets should heed the "very clear" warning Tokyo and Washington delivered last week on the yen.