Dollar advance slows ahead of key Fed decision

Dollar rally slows ahead of FOMC decision

The US dollar extended its advance on Tuesday against all its major counterparts. However, it seems to be stabilizing somewhat today as investors are likely reluctant to maintain large positions ahead of the FOMC rate decision later today.

Following last week’s sticky inflation data and the ongoing tensions in the Middle East, investors are now largely confident that the Committee will press the hike button. According to Fed funds futures, there is a 90% chance of a 25bps rate increase, while another same-sized hike is fully priced in for December. By the end of next year, there are around 95bps worth of rate hikes baked into the cake.

With all that in mind, a rate hike on its own is unlikely to shake the markets. Should it be delivered, the updated dot plot will quickly enter the spotlight, with the new forecasts following suit. At the press conference, investors will be eager to find out whether Fed Chair Kevin Warsh remains adamant on taming inflation, despite growing pressure from US President Trump over monetary policy.

Will policymakers satisfy market’s hawkish bets?

That said, even if Warsh appears more hawkish than Trump may have wanted, the big question is whether he will appear hawkish enough to satisfy market expectations. Considering that the June dot plot was pointing to only one rate hike this year, and a rate cut in 2027, the bar for matching the current market implied path may be very high.

Therefore, if the Fed convinces market participants to maintain bets of 95bps worth of rate hikes by the end of next year, the dollar is likely to extend its latest bullish stretch. On the other hand, anything pointing to a flatter rate path than the one anticipated by the market, even if the overall outcome has a hawkish flavor, could prompt greenback traders to liquidate some of their recently established long positions.

BoE to stand pat; BoJ ready to hike

The Fed is not the only central bank decision on investor’s agenda. Tomorrow, the BoE will get the torch, while on Friday, it will be the turn of the BoJ.

The BoE is widely expected to keep rates on hold, and thus, investors will focus on the voting pattern and the forward guidance. With the UK Overnight Index Swaps (OIS) market suggesting 100bps of hikes by the end of 2027, anything suggesting that officials are not in a rush to raise interest rates could weigh on the pound. Combined with a potentially hawkish Fed, pound/dollar could fall below the 1.3460 zone, aiming for the inside swing high of July 27, at around 1.3365.

As for the BoJ, traders see an 80% chance of a rate increase at Friday’s decision and thus, Ueda’s hints and clues about how officials are planning to move forward are likely to prove crucial. Following the coordinated intervention by Japan and the US, the latest suspicion of fresh rate checks, the hawkish remarks by both BoJ and government officials, as well as reports suggesting yen repatriation, policymakers may need to sound particularly hawkish for the yen to resume its rally.

Stocks feeling the heat of Fed hike speculation

On Wall Street, all three indices closed in negative territory as rising tensions in the Middle East and an extended oil rally bolstered speculation about higher interest rates by major central banks. Despite investors regaining confidence in AI spending, it seems that concerns about a faster increase in borrowing costs are outweighing that optimism. The Fed decision later today could be critical in determining whether the correction on Wall Street will continue, or whether a bounce is on the cards.

Gold hit support at around $4,260 yesterday and today it is recovering some ground, also awaiting the Fed before it assumes a clearer direction.