On Tuesday, the U.S. dollar index (USDX) saw a slight decline, briefly dipping below 105 and marking the fourth consecutive session of losses. This movement came after the dollar hit a six-month high the previous week. Investors are now gearing up for the Federal Reserve's upcoming interest rate policy decision on Wednesday.
The consensus expectation is that the U.S. central bank will keep interest rates unchanged during Wednesday's meeting — however, investors will closely scrutinize the Fed's stance on inflation and its future policy actions.
The optimism regarding the Fed's ability to orchestrate a smooth economic transition has persisted after a week of predominantly positive U.S. economic data. Even if the Fed decides to maintain higher interest rates for an extended period, the hope is that it can achieve a “soft landing” — a slowdown in economic activity that doesn’t result in a recession.
Francesco Pesole, FX Strategist at Dutch bank ING, wrote that the U.S. dollar index would keep close to the 105 mark going into tomorrow’s Fed meeting, with rising oil prices providing support for the currency:
“Investors are consolidating their positions ahead of a slew of risk events for markets this week. This will be the last quiet day before the action begins with the Fed meeting and UK CPI tomorrow, and then four central bank meetings in Europe (in chronological order: Sweden, Norway, Switzerland, UK) on Thursday. The dollar traded a little softer in yesterday’s afternoon session but has remained close to the March highs (DXY has stayed above 105.00). The rally in oil prices – Brent at $95/bbl – has been helping the dollar, both because the US is a net oil exporter and because it adds an argument against turning too optimistic on US inflation. It appears markets are happy to hold on to recently built dollar longs ahead of tomorrow’s FOMC, which suggests expectations are generally for a hawkish hold. CFTC data show that the net dollar positioning has increased for eight consecutive weeks and has now moved into net-long territory. Speculators remain net-long EUR/USD at +15% of open interest as of last week, which was however the lowest level since October 2022. That may cap the upside potential for the dollar, but as discussed in our Fed preview, there should still be enough in the dot plot projections to keep the dollar supported. Today, the US calendar includes housing starts and building permit figures for the month of August, which are unlikely to impact markets. DXY should keep trading close to 105.00 into the Fed.”
Markets.com Chief Market Analyst Neil Wilson shared his take on the upcoming FOMC meeting in an overview on Friday:
“The main question overhanging the meeting is on the dot plot. With the latest round of economic projections due, we will see whether policymakers still see one more hike this year. If the dots are the same as June, markets could move to price in a higher likelihood the Fed hikes in November and push back on when the Fed starts to cut. If the median dot is lower than the 5.6% forecast in June, then it could be the signal to the market that the Fed is done.”
The Fed's dot plot is a chart that documents the projected key short-term interest rate of each Federal Reserve official. Within this plot, the dots indicate the anticipated midpoint of the federal funds rate at the conclusion of each calendar year — typically three years into the future — based on the officials' expectations regarding the evolution of the economy. The officials also include a dot representing their projection for the longer term, which signifies the "neutral rate of interest." This neutral rate is the point at which interest rates are neither stimulating nor constraining economic growth.
Each dot on the chart corresponds to a specific Federal Reserve official, ranging from Chairman Powell to board member Lael Brainard, and from New York Fed President John Williams to Chicago Fed President Charles Evans. The identities of the officials behind each dot remain anonymous, preserving the confidentiality of their individual projections.
In his G10 FX Daily overview on September 19, Scotiabank Chief Currency Strategist Shaun Osborne wrote that the Fed would need to provide extra supportive comments at tomorrow’s meeting for the USD to continue to strengthen:
“Overall, markets appear in fairly constructive mood ahead of the Fed. The Fed may not sound dovish but markets may need quite a lot more supportive evidence to push an expensive looking USD (certainly relative to short-term yield spreads against its major currency peers) even higher at this point. US yields are bumping up against some key levels (5% or so for 2Y and 4.45% for 5Y) and a lot of good news still looks to be factored into the USD at this point. Recall that the DXY had advanced for nine consecutive weeks through last Friday and that sort of run usually leaves any market prone to some sort of consolidation or correction – which appears to be playing out, at least ahead of the Fed.”
In their most recent FX Snapshot dated September 11, analysts at Citibank Hong Kong’s Wealth Management division said:
“Medium term, global asset allocation may drive the USD. The Eurozone still has a bigger inflation problem than the US, suggesting some recovery in EU-US rate differentials. Besides, European equities are historically cheaper than the US and Europe discounts more bad news than the US ,which leaves the US more vulnerable to downside surprise. Capital flows away from the US should keep the USD weaker in the medium term.”
Citi’s last cited 3-month dollar index forecast placed the DXY at 102.6, which could decline to 98.74 in 6 to 12 months’ time. The bank’s long-term dollar forecast saw the DXY trading at a potential average of 93.48.
Economic data aggregator TradingEconomics was bullish on the dollar in its most recent USD forecast, projecting the DXY index to possibly trade at 106.73 by the end of this quarter. The platform’s 12-month dollar forecast estimated the index to trade at a potential 111.05 by September 2024.
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