US Dollar: Inflation-driven rate risks and premium – Commerzbank

Commerzbank's Thu Lan Nguyen highlights that higher-than-anticipated core US inflation has led to a near-ensured Federal Reserve rate increase this week and a greater chance of further hikes by year-end. However, the EUR/USD pair quickly reversed its initial dollar gains, as market participants grapple with uncertainties about the Fed's tightening measures and a rising risk premium tied to potential political clashes with President Trump.

Initially, the situation appeared unambiguous: US consumer prices (excluding volatile items) surged more than expected in August. Simultaneously, the Federal Reserve signaled that if inflation did not recede toward its target, it might need to tighten monetary policy. Consequently, following the inflation release, markets now consider an 90% probability of a rate hike during this Wednesday's meeting, and the chance of an additional increase before the year's end has also increased.

The forex market, though, presented a more complex picture. Immediately after the release, the US dollar surged as expected. Nevertheless, the surge soon faded. Shortly after, EUR/USD traded above its level before the release, and by the end of the day, the pair had nearly returned to its initial position. Commerzbank has previously cautioned that the Fed's independence could be endangered by persistent political pressure from the White House.

The central bank's predicament would only become apparent once its policy mandate directly clashed with the US administration's preferences, or more specifically, those of President Trump. If this pattern continues, the positive effects of higher US policy rates on the dollar might become increasingly diminished.