US economic data that exceeded market estimates and the success of the US government in avoiding a shutdown supported the dollar rally earlier this week.

The greenback can potentially register another bullish rally this week, following a brief profit-taking pause last week. Since the market opened yesterday, the US Dollar Index (DXY) has embarked on a marathon rally, reaching multi-month highs at 107.20 during Tuesday's (October 3rd) Asian session.

us dolar index

Two factors are currently supporting the US dollar rally. Firstly, market participants are relieved as the US has once again avoided the government shutdown threat. Secondly, the release of the latest US economic data reinforces the Federal Reserve's expectations of higher interest rates over a longer period.

The US Congress finally approved a temporary funding bill on Saturday, just hours before the deadline on October 1st. This law will fund the operations of the US federal government until November 17th, giving Democrats and Republicans additional time to discuss a budget that satisfies all parties.

Despite the antics of the political elite, US economic data continues to show a recovery pace that surpasses market estimates. The ISM reported that Manufacturing PMI increased from 47.6 to 49.0 in September 2023, which is better than the consensus estimate of 47.7. The data also indicates a significant decrease in the price sub-index, suggesting some success in the Fed's efforts to tame inflation.

Market participants responded to this series of news by pushing up US Treasury bond yields and the US dollar exchange rate. On the other hand, Wall Street stocks tumbled. This is because if the Fed raises interest rates again, US companies will have to bear higher interest costs for longer.

"It's the feeling that the U.S. economy can stomach higher interest rates for a little longer. Implicitly it also means that the Fed might not be so quick to cut rates next year either," said Bipan Rai, North America head of FX strategy at CIBC Capital Markets in Toronto.

"You are still seeing the U.S. growth story is much better than abroad, and that is probably going to keep that interest rate differential widely in its favor," said Edward Moya, senior market analyst at Oanda.

Top officials at the Fed concur. Michelle Bowman, a Federal Reserve Board of Governors member, stated yesterday that she is ready to support further interest rate hikes if necessary to achieve the Fed's inflation target. Her statement aligns with comments made by Federal Reserve President Neel Kashkari last week.