The US dollar (USD) has had an impressively strong run throughout 2021. With fluctuating fortunes over the first half of the year, there has been a huge run higher in the past six months. Traders have moved to price in a tightening cycle by the Federal Reserve. As we move into the New Year, the uptrend remains strong and there is room for further upside in the bull run. However, as 2022 develops, there are reasons why USD strength may not become a one-way trade.  

  • Further room for USD to run higher, at least in the near term
  • However, inflation seems to be peaking, this will hamper yields – the US yield curve is “bull flattening”
  • Markets do not appear to believe what the Fed is saying – the dot plots to be reined in

The near term outlook for USD remains positive 

Since a low of 89.53, the Dollar Index has gained over +8% in the past six months. The strength of the rally completed a base pattern on the Dollar Index in August with a move above 93.44. The implied target of 97.60 should be achieved at some stage during Q1 2022. From current levels, this gives another +1% to +2% of upside potential.


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The market is currently in a choppy consolidation but the uptrend remains strong and as yet there is still recovery potential. Even if 95.50 support were to be breached, the primary uptrend comes in at the previous key breakout at 94.75.  

Signs that inflation is beginning to fall

Inflation is expected to peak in the coming months. Already there are signs in the ISM data that inflationary pressures are beginning to ease. Here is a chart showing that the ISM Manufacturing Prices Paid Index is being dragged lower.

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We are also seeing that bond markets are suggesting inflation is peaking too. Ten-year inflation expectations (as measured on the US 10 Year Breakeven Inflation rate) have been trending lower throughout December, whilst US bond yields are also falling. The US dollar will struggle for continued gains if bond yields are not rising. 

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Perhaps there is some room to run if yields stay steady but inflation expectations fall (helping to increase the “real” yield). However, real yields remain fairly stuck around -0.9% to -1.1%.

The US Treasury bond yield curve continues to flatten. This comes when shorter-term bond yields rise (at the prospect of higher interest rates soon) but the longer-term yields are falling (at the expectation that tightening interest rates is going to damage the economy in years to come).


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A flattening of the yield curve is not something that will help a stronger US dollar in the months to come.

Markets do not believe the Fed on tightening

At the time of the last FOMC meeting, we pointed out that the terminal rate (where the Fed believes interest rates will end up) is up at +2.50%. However, looking at the curve of forward interest rate futures, markets believe that the Fed will struggle to get past +1.50%.

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This suggests that someone has got it wrong. To be brutally honest, the market does not trust the Fed has got this right. Here’s why:

  • The 10-year yield (a reflection of long-term interest rates) remains stuck between 1.50% and 1.75%.
  • The Treasury yield curve is inverted (suggesting tighter rates will end up damaging future growth prospects)  
  • Interest rate futures moving beyond three years out are stuck under 1.50%

Subsequently, all eyes will be on the Fed for any changes. Whilst the Fed will be raising interest rates at some stage in 2022 (probably between March and June), it may also begin to guide for a lower terminal rate. This could be the moment where USD strength begins to subside.


We believe that there is further to go in the US bull run higher into the early part of 2022. However, we are beginning to see the development of factors that could drive the reversal of USD strength. Subsequently, as the year develops, USD may not be the one-way trade that has been the case for much of 2021.