The Federal Reserve’s interest rate decision in September is the most important decision the central bank will make this year, with the potential to either declare the end of the US interest rate hike cycle or surprise FX markets, which already believed to be the case.
The vast majority of economists (94 of 97 polled by Reuters) do not expect US interest rates to change in September, while traders expect the next move in rates to be a cut in July next year. The best chance of another hike in this cycle is seen in December when there is a 40% probability that interest rates rise again.
What adds to the importance of the event and likely reaction to it is the fact that the dollar has gained around 6% in the preceding eight weeks, largely due to short covering. Oddly, this leaves traders with no bets on a drop at a point when the US central bank is expected to end the cycle of hikes underpinning it. Perhaps the dollar has been set up to fall.
The Dollar’s Fall
There are a few reasons why the dollar could fall after the Fed’s September decision. First, if the Fed does decide to pause rate hikes, it will be a signal that the central bank is becoming more cautious about the economy and inflation. This could lead to a sell-off in the dollar, as investors seek out riskier assets.
Second, if the Fed does not signal that it is prepared to cut rates in the near future, it could also lead to a weaker dollar. This is because investors would be less likely to hold dollars if they expect to be able to get a higher return on their money by investing in other currencies.
Third, the dollar’s recent strength has been largely due to short covering. This means that traders who had bet against the dollar are now buying dollars to close out their positions. Once this short covering is complete, there could be less demand for dollars, which could lead to a decline in the currency’s value.
Conclusion
The Fed’s September decision is a pivotal moment for the dollar. If the Fed decides to pause rate hikes or signals that it is not prepared to cut rates in the near future, it could lead to a weaker dollar.
In addition to the economic factors discussed above, there is another unique angle to the Fed’s September decision. In recent months, the dollar has become increasingly politicized. Some US politicians have accused the Fed of deliberately weakening the dollar in order to boost exports.
If the Fed does pause rate hikes in September, it could be seen as a concession to these politicians. This could further undermine the dollar’s status as the world’s reserve currency and lead to a more volatile global currency market.
Overall, the Fed’s September decision is a complex event with far-reaching implications for the dollar and the global economy.