The US dollar remained at a 2-1/2 month high on Tuesday, supported by expectations that the Federal Reserve will approach interest rate cuts cautiously. This strength in the dollar, further reinforced by rising Treasury yields, continued to put pressure on the yen, euro, and sterling. This trend has been gaining momentum in recent weeks as traders pull back on expectations of rapid US rate cuts.

Charu Chanana, Chief Investment Strategist at Saxo, commented, "The US exceptionalism story remaining intact and what Fed speakers are hinting at are gradual rate cuts from here. This, together with the betting odds of a Trump 2.0 picking up, has brought another leg of gains for the U.S. dollar."

The dollar index, which tracks the US currency against six others, stood at 103.87, having reached 104.02 on Monday, its highest level since Aug 1. So far this month, the index has risen by over 3%.

The upcoming Beige Book, due to be released on Wednesday, is seen as a potential risk for the dollar, according to some analysts. The previous report on economic conditions was viewed as a key trigger for the 50 basis point rate cut in September, which marked the start of the Federal Reserve's easing cycle.

Four Federal Reserve policymakers expressed their support for further rate cuts on Monday, though they appeared divided on the pace and extent of the cuts. Currently, markets are pricing in an 87% probability of a 25 basis point rate cut next month, compared to a 50% chance of a larger 50 basis point cut a month ago, according to the CME FedWatch tool.

Traders are now expecting an additional 40 basis points of easing by the end of the year.

The euro was last seen at US$1.0827, close to its lowest point since 2 August, while sterling stood at US$1.3006, near its lowest since 20 August. Thursday's eurozone PMI data could put further pressure on the single currency if it highlights the region's poor economic performance, bolstering the likelihood of European Central Bank (ECB) rate cuts.

Francesco Pesole, Forex Strategist at ING, remarked, "The key question is: are the hawks fine with Lagarde's sanguine disinflation view, a gradual shift in focus to growth and such a dovish market pricing?" He added that persistent inflation in the euro zone services sector may mean the answer is no.

With the US election just two weeks away, the rising odds of a Donald Trump victory are also boosting the dollar. His policies on tariffs and taxes are seen as potentially keeping US interest rates elevated. However, the race remains tight, and analysts expect market volatility in the lead-up to the election results. Antti Ilvonen, Forex Analyst at Danske Bank, noted, "Even small changes in tight polls could drive seemingly erratic swings in market sentiment."

Meanwhile, the yield on the US 10-year Treasury note rose to 4.22%, its highest since July 26, which kept the yen under pressure. The Japanese yen was relatively unchanged at 150.82 per dollar, after hitting a near three-month low of 151.10.

Takeshi Kato, Executive Director of the Bank of Japan, highlighted concerns about rising import prices due to the weakening yen. Japan is set to hold a general election on Oct 27, and despite varying opinion polls, markets are optimistic that the ruling Liberal Democratic Party (LDP) and its coalition partner Komeito will maintain their positions.

Reuters