US Dollar: Fed hike expectations and limited gains – MUFG

MUFG's Lee Hardman observes that the US Dollar (USD) has only experienced modest growth despite markets anticipating a Federal Reserve rate hike at this week's FOMC meeting. A combination of higher US inflation and heightened hawkishness in the US yield curve has bolstered the Dollar, but concerns over policy credibility, energy-related inflation, and timing of US mid-term elections may limit near-term gains.

The USD index has climbed back above its 200-day moving average at approximately 99.150. The dollar benefited from the Fed's increased expectations for rate hikes, which were triggered by stronger US inflation data last week. With 22 basis points of hikes now priced in for this week's meeting, compared to approximately 15 basis points a week prior, the positive impact of the hawkish Fed stance on the USD has been limited so far.

If the Fed fails to act on inflation risks this week, it could lead to a significant decline in the USD and long-term US Treasuries, as markets lose faith in their ability to control inflation. This may be why USD gains have been limited so far following the Fed's hawkish stance. The close proximity of the US mid-term elections could also restrain further USD gains, even if the Fed initiates rate hikes this week.

The Fed may be hesitant to deliver consecutive rate hikes before the mid-term elections on November 3rd, possibly holding off until December 9th. The AUD/USD pair reached a one-and-a-half-week low around 0.7140 during the Asian session but lacks follow-through, trading just above mid-0.7100s, down nearly 0.25% for the day. The USD/JPY pair shows some buying interest at the beginning of a new week, nearing the 154.00 mark, reversing part of Friday's losses, but remains in a range from the past week and close to a seven-month low.