Dollar girded by bets on a US hiking cycle

The U.S. dollar showed resilience on Wednesday as it hovered near multi-week highs, positioning itself ahead of a Federal Reserve decision where traders anticipate a possible first interest rate hike among several. A 25 basis-point increase, priced at 90%, indicates the dollar may receive a minor boost from the Fed, based on insights from Carol Kong, a currency strategist at the Commonwealth Bank of Australia.

The possibility of the dollar weakening in the event of a rate hike is slim, as Fed Chair Kevin Warsh has downplayed the chances of additional hikes in a subsequent press conference. However, should the Fed refrain from raising the funds rate, experts estimate a significant 1%+ decline in the dollar.

Overnight, the dollar surged alongside yields, drawing notably against the yen and New Zealand dollar. This surge led the kiwi to its two-month low of $0.5749 and the yen to a one-week low of 155.43 per dollar. The euro, at $1.1535, was close to its one-month low of $1.1523, while the British pound, at $1.3470, was slightly above its six-week low of $1.3464. The Australian dollar remained relatively stable at $0.7126.

Interest rate fluctuations have been relatively subdued due to the convergence of global bond yields as sovereign bonds across countries have experienced minimal relative yield shifts. However, the dollar gained momentum in recent sessions, fueled by the belief that despite Kevin Warsh's appointment by President Donald Trump to ease interest rates, he may be compelled to hike multiple times to demonstrate the Fed's commitment to curbing inflation.

This inflation surge has been exacerbated by tensions with Iran and escalating energy prices. Calvin Tse, head of U.S. strategy and economics at BNP Paribas, expressed skepticism about the Fed's ability to restore credibility with markets through one or two hikes.

The exceptions to the overall stability in foreign exchange rates are mostly observed in Asia, where the yen has emerged as a standout performer. There is an 80% probability that the Bank of Japan will raise rates on Friday, according to LSEG data. Traders have priced in two 25-basis-point hikes by the end of January. The yen's trajectory will continue to be influenced by interest rate differentials, as emphasized by economist David A. Meier of Julius Baer, who recently revised the USD/JPY forecast to 155, highlighting doubts about the central bank's ability to meet the current market-predicted pace of tightening.

Uncertainties persist, including the political inclination towards low interest rates amidst ongoing fiscal expansion.

South Korea's won, which has risen over 15% against the dollar since the end of June due to capital repatriation and profits from chipmaking enterprises, and China's stable yuan are other notable regional currencies. While the yuan's long rally has softened to around 6.71 per dollar, it continues to maintain its gains, despite the widening gap between low Chinese yields and global rates.