The American currency amazes market participants with its extraordinary vitality. Investors and traders resumed speculation that the Federal Reserve will hit a pause button in monetary tightening. It would seem that such a prospect should send the greenback into a downward spiral, but USD still finds the strength to stay afloat. What supports USD? Will it be able to show off its muscles again in the near future?

Hawkish ambitions of US dollar

On Wednesday, the US currency traded on a seesaw. In the first half of the day, the greenback took a nosedive against a basket of major currencies, with its index having reached 103.64.

However, later the US dollar index bounced up in confidence which allowed it to return to the already familiar 104 area.

The initial drop in the greenback was due to a hawkish surprise from the Bank of Canada. Yesterday, the regulator astonished the markets with the first rate increase since January.

Defying expectations, the Canadian central bank resumed tightening, citing growing fears that inflation could stay well above its target for a long time.

The decision of the Bank of Canada followed the rate hike in Australia. On Tuesday, the Reserve Bank of Australia increased the cash rate by 25 basis points, although economists expected the regulator to keep it at the same level.

To be sure, the more aggressive policy of major central banks is negative for the US dollar, which may well not regain bullish momentum from the Fed next week, given the recent dovish comments from Fed's policymakers.

However, the fact that 2 regulators at once went against market expectations and continued to tighten their monetary policies, of course, aroused optimism among market participants.

Now traders estimate the probability that the Fed will raise the key interest rate this month at about 29%, which is 10% higher than a day ago.

As you can see, most investors still expect the regulator to take a breather in June. However, in light of recent events, the likelihood of a rate hike in Jul has increased notably (up to 80%).

The growth of inflationary expectations in the US also contributed to the rising hawkish market sentiment. According to the St. Louis Fed, 5-year inflation expectations climbed to their highest level in a week and amounted to about 2.15%, while the 10-year forecast updated a weekly high at around 2.21%.

The prospect that high inflation could stay with the Americans for a long time increased the likelihood of at least another round of rate hikes in the US, which triggered a jump in US Treasuries yields.

In the New York session yesterday, the 10-year Treasury yield rose by about 10 bp to peak at 3.801%. This provided significant support to the US dollar, which closed the session higher, albeit with a small but very encouraging plus.

In the coming days, analysts predict the consolidation of the US dollar index against the backdrop of an almost empty economic calendar. They warn traders of strong volatility on Forex as early as next week, when the US inflation report for last month will be released.

The May release of the CPI should become the main reference point for the Fed in determining the further agenda for its monetary policy.

Sustained inflation could further reinforce the view that the Fed will continue to be aggressive in its next meetings and is unlikely to cut rates in the second half of the year.

The majority of currency strategists polled recently by Reuters believe that the dollar will remain strong against all its competitors in the medium term. Major currencies such as EUR, GBP, and JPY will not be able to recover their highs against the USD until at least September.

According to experts, only a dovish reversal in the Fed's rhetoric can significantly weaken the US dollar in the foreseeable future. However, about 70% of respondents said they expect the Fed to cut the rate no earlier than next year.

Extra bullish factor for USD

The risk-off mood of traders will continue to be another springboard for the US dollar in the near future. Fears of a global recession have not faded away even after US policymakers settled a highly-anticipated deal to raise the national debt ceiling.

A new threat to the global economy is China's rather unstable recovery. On Wednesday, the Celestial Empire published fresh data on trade, which turned out to be very weak.

In May, China's exports broke a 2-month growth streak and fell by 7.5% year-on-year, while economists had expected a decline of only 0.4%.

The slump in Chinese exports casts doubt on the recovery of the world's second-largest economy, which worsens the risk of a global recession.

Besides, the recent hawkish decisions of the Bank of Canada and Australia are heating up the situation on world markets. This week, regulators not only raised interest rates but also warned of a possible continuation of an aggressive policy against due to persistent inflation.

If monetary conditions continue to tighten around the world, this will put pressure on global demand, which in turn will lead to a slowdown in global economic growth.

The Organization for Economic Co-operation and Development (OECD) highlighted such prospects on Wednesday. Its latest report says the global economy is set to see a weak recovery in the coming years due to the hawkish policies of major central banks.

Now, many analysts believe that the recession fear will again force investors to abandon risky assets in favor of safe havens. One of the beneficiaries, as usual, will be the US dollar.