US Dollar: Warsh message supports limited upside – MUFG

MUFG’s Derek Halpenny notes the US Dollar is holding most of its post-FOMC gains after a 25bps hike and hawkish guidance from Fed Chair Warsh. The Fed’s projections imply only gradual disinflation and a higher long-run rate, but market pricing had already anticipated more tightening. Halpenny expects one further Fed hike, with Dollar upside constrained as other G10 central banks also raise rates.

Fed hike and guidance back Dollar

"The US dollar has held on to most of last night’s gains following the FOMC decision to hike the fed funds rate by 25bps and provide communications that certainly suggest the scope for further action ahead. The headline grabbing comment from Fed Chair Warsh that the hike had “removed a dose of accommodation” was the clearest signal that a certain level of accommodation still exists and therefore more action will be required. That was also underlined by the fact that the YoY core CPI rate only hits the 2% target in 2029."

"In the same light, we possibly shouldn’t read too much into the median dot levels and those levels could and very likely will change as developments unfold moving forward. The 4.125% median dot for 2026 and 2027 points to another hike and then no cuts until 2028 when the median dot drops by just 25bps and then by another 25bps in 2029 to 3.625%. That’s a very cautious removal of the two hikes pencilled in for this year that certainly implies a faster reduction in core CPI will require more than just one additional hike."

"But while Warsh was hawkish and emphasised again his focus on achieving price stability, the bar was high going into the meeting for a large sell-off in rates and/or advance for the US dollar. Clearly UST bond yields had moved in advance of the decision with larger moves higher in yields on 10th September than the reaction yesterday. The OIS curve ahead of the meeting was priced for more than the two hikes signalled by the 2026 median dot and that should help contain the rates and FX reaction for now with the focus back on the data to determine whether those pushing for more than one further hike will start to have greater say."

"The US dollar gains ahead should also be curtailed by the fact that other central banks are set to turn more active in hiking rates as well. We have altered our view for the ECB (we now assume two further hikes to 3.00%) and the BoE (we have added two hikes to our core view) while the BoJ is set to speed up the pace of tightening (as we expected). Every G10 central bank, bar the SNB, is priced to hike by year-end."

"Front-end rate spreads (2-yr swap) do not point to further dollar buying from these levels, except for USD/JPY."

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