US Dollar Index: Fed pricing supports gains – Scotiabank

Scotiabank analysts Shaun Osborne and Eric Theoret highlight that the US Dollar (USD) begins FOMC week on a robust note, following an 85% probability of tightening priced in by swaps. The US Dollar Index (DXY) is currently fairly valued against front-end spreads, and further gains above 100 would demand significant changes in yield differentials that the Fed may not be willing to provide.

The USD starts FOMC week on a firm note, reflecting the shift in expectations due to last week's US inflation data. Swaps now indicate a 21 basis point (or 85%) chance of tightening during Wednesday, with the Bloomberg survey showing a narrow majority favoring a hold. Historically, swaps pricing that indicates a 70% or higher chance of a Fed rate move has accurately predicted a policy decision, making dollar gains in response to such pricing logical.

However, an unchanged Fed decision would be a shock for markets and negative for the USD, while a dovish hike that fails to commit to further rate hikes could also weigh on the USD. The DXY is assessed to be fairly priced given current front-end spreads, and further gains above the 100 level would require a substantial move in yield differentials, which the Fed is not currently prepared to provide.