Dollar gets little lift from boost in Fed hike expectations

The US dollar faced challenges on Monday, despite an increase in expectations for Federal Reserve rate hikes. Middle East tensions and concerns over rising inflation added to the pressure on the currency. The shift in sentiment towards the Japanese yen and worries about the growing US debt and policy uncertainties also impacted the greenback.

Early Asian trading saw subdued moves in currencies, with US markets closed for a holiday. The euro saw a slight increase, while the British pound remained relatively unchanged. Against a basket of currencies, the dollar dropped 0.07%, nearing a recent low of 98.558. Traders were pricing in a 57% chance of a Federal Reserve rate hike this month, contingent on Friday's inflation data.

If a hot Consumer Price Index (CPI) reading materializes, it could solidify a September rate hike and bolster the US dollar. However, a cooler reading might strengthen the case for a rate hold, leaving the US dollar vulnerable to a more dovish Federal Reserve. Even if a September Fed hike is inevitable, it is unlikely to propel the US dollar to new cyclical highs, given the tightening by other major central banks, which limits policy divergence.

Inflationary pressure from elevated oil prices is a significant factor, prompting the European Central Bank to raise rates to 2.75% on Thursday, with a 75% chance of another hike to 3.0% by December. Similarly, markets anticipate a 75% probability of the Bank of Japan raising rates by a quarter point at its meeting on September 18, with a 60% chance of further increases by December.

The Japanese yen gained over 0.2% to 155.88 per dollar on Monday, extending gains after Japan's Prime Minister Sanae Takaichi's economic adviser predicted a BOJ rate hike this month. While carry trades have been a strong macro performer so far this year despite rising global borrowing costs, Eric Robertsen, global head of research and chief strategist at Standard Chartered, cautioned that the recent surge in yen strength could pose a threat to carry trade outperformance.

If the yen continues to strengthen persistently, it may indicate that the increasing rates between yen and the US dollar are beginning to prompt a shift in asset allocation. In other currencies, the Australian dollar rose 0.12% to US$0.7208, while the New Zealand dollar held steady at US$0.5880. Bitcoin steadied above the US$80,000 mark, supported by investors seeking to diversify away from the US dollar into other assets.