US Dollar: Inflation-driven rate risks and premium – Commerzbank

Commerzbank’s Thu Lan Nguyen notes that stronger-than-expected core US inflation has pushed market pricing toward a near-certain Federal Reserve rate hike this week and higher odds of another move by year-end. However, EUR/USD quickly retraced its initial Dollar gains, as investors weigh doubts about the Fed’s tightening sufficiency and a rising USD risk premium linked to potential political confrontation with President Trump.

Fed hike odds and Dollar risk

"At first glance, the picture seemed straightforward: US consumer prices excluding volatile components rose more strongly than expected in August. At the same time, the Fed had recently made it clear that if inflation failed to show signs of moving back towards its target, it would feel compelled to tighten monetary policy. As a result, following the inflation release, markets now price in a nearly 90% probability of a rate hike at this Wednesday's meeting, while the likelihood of an additional increase before year-end has also risen."

"The picture in fx markets, however, was far less clear-cut. Immediately after the release, the US dollar appreciated as one would have expected. Yet the move quickly lost momentum. Before long, EUR/USD was at times trading above its pre-release level, and by the end of the day the pair had essentially returned to where it started."

"Indeed, we have long warned that the Fed's independence could come under threat from sustained political pressure emanating from the White House. The central bank's dilemma, however, would only become visible once its policy mandate clearly came into conflict with the preferences of the US administration, or more precisely, those of the US President."

"If this trend persists, the positive impact of higher US policy rates on the dollar could become increasingly diluted."

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