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Currency markets have settled in to wait for the Fed's 1800 GMT
announcement and Chairman Jerome Powell's news conference,
having endured wild gyrations in recent weeks, with the dollar
soaring to 20-year highs against a basket of currencies.
Money markets are betting the Fed will raise rates as high as
3.6% by the end of 2023 to tame inflation at 40-year highs.
Having kicked off its hiking cycle in March, the Fed is seen
delivering a 50 bps move on Wednesday, with two more half-point
hikes priced for the next two meetings.
It may also announce when it will start reducing its $9 trillion
balance sheet.
Those bets lifted the dollar index 5% last month to around
103.93. It has since slipped 0.3% off those levels and by 1030
GMT was at 103.40, slightly lower on the day.
"A major correction in the dollar would happen only if the Fed
pushes back against hawkish market pricing and until they do
that, there is a degree of freedom for markets to reprice the
terminal rate to 4%," ING Bank strategist Francesco Pesole said.
"We are also in a situation where if you let go of dollar
positions, where do you put your money?" Pesole asked, noting
the effect of the Russia-Ukraine war on Europe and the economic
slowdown in China.
Dollar strength has weighed on other currencies, pushing the
euro last week to two-decade lows around $1.0469. It stood at
$1.0525 on Wednesday.
"The fundamentals, the interest rate difference, the growth
outlook, the risk-off mood, all tend to favour the dollar," said
Gergely Majoros, member of the investment committee at Carmignac.
"A lot of factors point to a stronger dollar and weaker euro ...
in our global portfolio we have increased dollar positioning."
Some note markets' expectations of future U.S. inflation -
so-called breakevens - derived from Treasury inflation-protected
securities (TIPS) have eased, with 5-year breakevens around
3.2%, versus April highs of 3.6%.
ING's Pesole dismissed the moves, however.
"If the Fed provides an indication they will aggressively
front-load the tightening cycle and the back end of the Treasury
curve comes off a bit, that will be the indication that markets
are starting to price the Fed getting ahead of the curve (on
inflation)," he added.
Elsewhere, the Australian dollar rose 0.4%, benefiting from
Tuesday's bigger-than-expected interest rate hike.
(Reporting by Sujata Rao; Editing by Dhara Ranasinghe and Mark
Potter)
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