US Dollar Index: Fed pricing supports gains – Scotiabank

Scotiabank strategists Shaun Osborne and Eric Theoret note the US Dollar (USD) is firm at the start of FOMC week as swaps now price an 85% chance of tightening on Wednesday. They highlight that US Dollar Index (DXY) is fairly valued versus front-end spreads and argue further gains above 100 would require a significant move in yield differentials, which they doubt the Fed is ready to deliver.

Dollar firm into key FOMC

"The USD starts FOMC week on a firm note, reflecting the shift in expectations around the policy decision on Wednesday following last week’s US inflation data. Swaps reflect 21bps (or 85%) of tightening risk for Wednesday while the Bloomberg survey now shows only a very narrow majority of respondents favouring a hold."

"In recent years, swaps pricing which indicated 70% or higher risk of a Fed rate move has been a near perfect indicator of a policy move, so dollar gains in response to swaps pricing is understandable. There are still some risk around the outlook, however."

"An unchanged decision from the Fed would be a shock for markets and a clear negative for the USD. But a “dovish” hike which does not obviously commit to additional moves would also likely weigh on the USD."

"The DXY is about fairly priced for where front-end spreads are right now. Further DXY gains—holding above the 100 level—will need the support of a significant move in yield differentials and it’s not clear to us at this point that Fed is prepared to lift rates to that extent."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor. Know more.)