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Dollar softens as Fed hike bets shift toward December

Analysts at MUFG/BTMU note that they “still expect the Fed to hike rates one more time this year in December” and, after stronger US inflation data for September, “can’t completely rule out the probability of another back-to-back hike this month.” They point out that the US rate market has recently been “scaling back Fed rate hike expectations for this month” and that “there is currently only around 4bps of hikes priced in” after Fed officials, including Chair Kevin Warsh, “refrained from signalling that they are in a rush to raise rates further after tightening policy for the first time last month.” According to MUFG/BTMU, this “scaling back of October Fed rate hike expectations has helped to dampen the US Dollar’s upward momentum in the near-term although further hikes remain likely.”

Commerzbank’s experts similarly highlight that “for October - that is, next week - a rate hike by the Fed is generally no longer expected,” with “a hike in December…already priced in” and the market still seeing “a chance that another hike could come by the middle of next year.” However, they stress that their own baseline is more cautious, stating that they “do not foresee any further hikes after December.” In their view, “if the Fed delivers a hawkish pause next week, the Dollar could gain some ground, at least in the short term,” whereas “any deviation from a restrictive stance - which would cause the market to revise its expectations downward, especially for next year - is likely to put the Dollar under pressure.”

From a broader market perspective, ING observes that “the Dollar continues to trade with a soft undertone,” attributing this partly to “some aftereffects of AI-related concerns (Corewave bonds had another wobble yesterday) and stretched longs/ short-term overvaluations being unwound.” At the same time, ING judges that “the Dollar no longer looks particularly stretched on our short-term valuation metrics” and acknowledges that “the softer Dollar backdrop has shifted the balance of risks somewhat further in a USD-bearish direction.” Even so, ING continues to “favour a gradual and orderly Dollar decline rather than a sharper depreciation,” arguing that “the broader Fed, oil and rates narrative remains supportive.”