The U.S. dollar surged to its highest level since July 2020 against other major currencies on Thursday. The day before, the Fed said it could raise interest rates faster and more significantly in the coming months. Money markets are now pricing in as many as five rate hikes of 25 basis points each by the end of the year, as the Fed signaled it was ready to start raising interest rates in March to stem a spike in inflation. The Fed's hawkish tone on Wednesday sent investors rushing to long the dollar. The U.S. dollar index, which measures the greenback against other major currencies, rose to 97.299, its highest level since July 2020, and its 0.8 percent gain was the biggest one-day gain in more than two months.

Ed Moya, senior market analyst at OANDA, said the prospect of significant rate hikes has led to a major global reset. You have no idea how far the Fed will go because we don't know exactly when inflation will actually peak. Despite market optimism that inflation will ease by mid-year, inflation could pick up and lead to more aggressive Fed action, he said.

The Fed's expectations are largely dependent on the performance of the U.S. economy, which may be weaker than it appears. The U.S. Department of Commerce announced on Thursday that in the fourth quarter of 2021, the U.S. gross domestic product (GDP) grew at an annual rate of 6.9% year-on-year, and the economy grew by 5.7% in 2021, the fastest growth rate since 1984. Strong economic growth supported a rate hike in March. But inventory rebuilding contributed nearly three-quarters of the strong GDP growth figures, said Joe LaVorgna, chief economist for the Americas at Natixis, which is not what a strong economy does.

The U.S. dollar index rose 0.83% at one point, its biggest gain since early November, the U.S. dollar strengthened against all G-10 currencies, the Australian dollar underperformed, and the offshore renminbi suffered its biggest drop since July. The 2-year U.S. Treasury yield rose 4 basis points to 1.19%, while the 10-year Treasury yield fell 6 basis points to 1.81%.

EUR/USD dipped 0.95% to 1.1132, its lowest level since June 2020; stops were triggered below the Nov. 24 low of 1.1186. The Swiss franc fell as ECB policymakers Rehn and Kazimir made dovish comments on inflation.

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