The dollar is poised for its strongest monthly performance since June, as the Federal Reserve's renewed focus on curbing inflation pushes rate expectations and Treasury yields higher.

The Bloomberg Dollar Index rose 1.9% in September, touching its highest level in two months. Robust U.S. economic data and mounting inflation risks have provided support to the greenback. The Iran war has kept energy prices elevated and driven Treasury yields to historic highs, with the 30-year yield reaching its highest level since 2002.

Markets now expect the Fed to raise rates by nearly 1 percentage point over the next 12 months, which would further bolster the dollar. "The dollar's trajectory continues to be guided by U.S. economic data," said Jayati Bharadwaj, head of FX strategy at TD Securities. "Surprises in U.S. economic data will serve as the directional signal for the dollar in the near term, and will also determine whether the magnitude of Fed rate hikes aligns with market expectations."

The dollar's rally was triggered after the Fed raised rates for the first time in three years, and was subsequently reinforced by hawkish comments from policymakers. Federal Reserve Governor Michael Barr reiterated on Tuesday that further rate increases may be necessary to curb inflation. Similarly, New York Fed President John Williams expressed a comparable view, stating that one more rate hike "may be appropriate later this year to help bring inflation back to target more promptly."

Widening interest rate differentials and strong U.S. economic growth have also forced dollar bears to reconsider their positions. Morgan Stanley recently abandoned its long-held view that the dollar would weaken in the second half of 2026. Traders are now closely watching the September employment report due on Friday, which will test market expectations for aggressive monetary tightening. The U.S. will also release the August Personal Consumption Expenditures price index on Wednesday, the Fed's preferred inflation gauge.

Global inflation risks remain elevated, but not all economies are capable of withstanding larger rate increases. Expectations of divergent rate paths are driving the dollar's movement against other major currencies. With the exception of the yen, G10 currencies all depreciated against the dollar in September. Rising risks of Japanese authorities intervening in the foreign exchange market, along with expectations that the Bank of Japan will raise rates further, are supporting the yen.

However, some indicators suggest the dollar's rally may be showing signs of fatigue. A gauge measuring dollar momentum climbed above 70 on Tuesday, indicating the dollar may already be overbought. On September 24, the Bloomberg Dollar Relative Strength Index also entered overvalued territory. "We believe the dollar is beginning to show signs of fatigue," said Noah Buffam, strategist at CIBC Capital Markets. Kamakshya Trivedi, head of global FX and rates forecasting at Goldman Sachs Group, expects the dollar to trade within its current range and predicts the Fed will raise rates only once more in October.