S. Korean won retreats against U.S. dollar ahead of Fed decision

The US dollar gained strength on Monday as investors speculated about potential interest rate hikes from both the Federal Reserve and the Bank of Japan later in the week. The yen approached a seven-month high due to uncertainty surrounding the monetary policy decisions. Global policymakers are facing challenges from the ongoing US-Israeli war in Iran, which has driven oil prices above $100 per barrel and disrupted the outlook for interest rates amid fluctuations in long-term bonds.

The European Central Bank increased rates the previous week and hinted at further hikes, paving the way for the Federal Reserve's policy decision on Wednesday and the Bank of Japan's anticipated rate hike on Friday. The Bank of England is likely to maintain its stance on Thursday, with the vote expected to be tight. Speculation increased for a Federal Reserve rate hike following data showing a surge in U.S. consumer prices in August, with traders pricing an 86% chance of an increase this week and another rise later in the year according to the CME FedWatch tool.

Fed Chair Kevin Warsh may need to back his strong words with action to maintain credibility in controlling inflation. Meanwhile, the euro weakened by 0.1% to $1.1585, and the British pound reached $1.3516. The US dollar index, which tracks the greenback's value against six other currencies, rose by 0.12% to 99.22 after two weeks of modest declines.

U.S. Treasury yields hovered near multi-year highs, including the 2-year yield, which dipped slightly to 4.6148% after jumping 26 basis points the previous week. The increasing yields and evolving rate expectations have yet to propel the dollar higher, as major economies' central banks are also anticipated to raise rates, while concerns about the Federal Reserve's policy credibility persist.

There is a remote possibility that the US dollar could weaken if the Federal Reserve hikes rates, but Fed Chair Warsh has downplayed the likelihood of additional hikes in subsequent press conferences. Brent crude futures surged nearly 3% to $107.6 per barrel as fresh Houthi strikes on Saudi Arabia and Iranian attacks on ships in the Gulf exacerbated supply worries following the closure of a key Saudi oil pipeline.

The Japanese yen weakened by 0.3% to 154.03 per US dollar, but it remained close to a seven-month high of 152.89 reached last week. Speculators began holding a net long position in the yen for the first time since February. For the yen to appreciate further, the Bank of Japan will have to indicate a commitment to maintaining a faster pace of hikes.

If the Bank of Japan fails to raise rates at its October or December meeting, the US dollar/yen rally could potentially return to the 157-160 range. TD Securities analysts believe the Bank of Japan will likely hike interest rates at least once every quarter, diverging from its usual semi-annual approach. The yen has risen by 4% this month, fueled by expectations of more aggressive rate hikes from the Bank of Japan and indications of domestic investors repatriating assets.

Failing to act decisively or communicating effectively could prove to be a grave mistake, according to James Athey, a fixed-income portfolio manager at Marlborough.