Dollar firms near one-month highs ahead of Fed decision

The U.S. dollar approached one-month highs on Wednesday, driven by investor anticipation of a Federal Reserve interest-rate decision, which some analysts suggest could include a surprise increase. The dollar index, tracking its performance against a basket of six major currencies, saw a modest gain, reaching 101.46.

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For the dollar, if policy is left unchanged then the currency may weaken. But any material hawkish dissent would limit the damage, and the dollar may recover during the (Fed) press conference. A hike would be a clearer bull signal for the currency.

Adding to market uncertainty, hostilities in the Middle East escalated. Joint strikes by the U.S. and Saudi Arabia targeted Iran-backed groups in Iraq, following a U.S. military report of averting an Iranian attack. This heightened geopolitical tension contributed to a rise in oil prices.

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We're going into this meeting with a round of one-in-three chance for a rate hike priced in. First time we've seen pricing like that for a while.

Despite these developments, currency markets remained largely subdued. Investors adopted a cautious stance, awaiting the Federal Open Market Committee's (FOMC) decision. Markets currently price in approximately a 36% chance of a 25-basis-point rate hike. The euro dipped slightly by 0.09% to $1.1378, and sterling fell 0.04% to $1.3284, hovering near its weakest point since early July.

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There is genuine uncertainty around this meeting, and I would expect that to lead to some volatility on the outcome, whichever way it breaks.

Analysts suggest that if the Fed leaves policy unchanged, the dollar might weaken. However, any indication of a hawkish stance could mitigate losses, potentially leading to a dollar recovery during the subsequent press conference. Conversely, a rate hike would serve as a clearer bullish signal for the currency. The Swiss franc and Japanese yen also experienced slight declines against the dollar, with the franc trading near one-year lows and the yen remaining close to a 40-year low, prompting vigilance for potential intervention by Japanese authorities.

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Switzerland's low rate environment has made dollar/Swiss a very popular vehicle to express hawkish Fed views. Were the Fed to blow the doors off with a hike....dollar/Swiss could be looking at 0.85 in August.