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Greenback extends rally as investors reassess fed rate cut expectations amid resilient US economy and geopolitical uncertainty

The US dollar maintained its upward momentum on October 7, fueled by robust US jobs data and geopolitical tensions in the Middle East. Japan's yen hit a nearly two-month low, slipping to 149.10 per dollar before recovering slightly to 148.40. The yen had already suffered a 4% decline last week, marking its sharpest weekly drop since early 2009.

The dollar's strength was sparked by Friday’s US employment report, which revealed the largest job gains in six months for September, along with a decline in the unemployment rate and solid wage growth. These indicators suggest the US economy remains resilient, causing markets to reassess the likelihood of interest rate cuts by the Federal Reserve.

Chris Weston, head of research at Australian online broker Pepperstone, commented on the situation, stating, “With rate cuts still being the default position, and when married to upbeat earnings expectations and China going hard on liquidity and fiscal, the equity bull case and the US dollar get a shot in the arm.”

However, geopolitical risks remain a looming threat. Over the weekend, Israel escalated its military actions, bombing Hezbollah targets in Lebanon and Gaza. This comes ahead of the first anniversary of the attacks that led to the ongoing conflict, raising fears of an energy supply shock. Brent crude oil futures dropped 0.4% on Monday but surged over 8% last week, the largest weekly gain since early 2023.

Despite these geopolitical concerns, traders remained optimistic about the dollar. The dollar index, which measures the greenback against a basket of major currencies, held steady after Friday's 0.5% rise to a seven-week high. Over the week, it logged a 2% gain, its largest in two years.

Meanwhile, the yen’s recent weakness is also linked to comments from Japan's new Prime Minister, Shigeru Ishiba, suggesting that rate hikes in Japan are still distant. US Treasury yields, which dipped last week amid a flight to safe-haven assets due to Iran-Israel tensions, remained elevated, hovering around 3.97%.

The Federal Reserve's November policy decision is now the focus for many investors. Market expectations have shifted towards a 25-basis-point cut rather than a more aggressive 50-basis-point cut. CME’s FedWatch tool shows a 98% chance of a smaller cut, up from 47% a week ago.

In other currency markets, the euro traded slightly lower at $1.0970, while the British pound remained flat at $1.3122 after a 1.9% decline last week. The New Zealand dollar paused its week-long slide ahead of a key Reserve Bank of New Zealand decision, with expectations of a significant rate cut.

As Ryota Abe, an economist at SMBC in Singapore, put it, “Dollar-yen will be staying around 145-149 in coming weeks due to lower expectations on an outsized cut by the Fed in November and dovish stance of Japan's PM ahead of the general election on October 27, as long as the Middle East tensions remain subdued.”