Why is the US Dollar firm when the Federal Reserve hike is already fully priced in?

The US Dollar (USD) is trading with a firm undertone heading into the Federal Open Market Committee (FOMC) interest rate decision, supported by a relentless march higher in US Treasury yields that has pushed the 10-year yield to 5.00% and the 2-year yield to 4.66%. Financial markets have almost fully discounted a 25 basis point rate hike, bringing the benchmark policy rate to 4.00%. Driven by persistent commodity price pressures — with Brent crude holding above $100/bbl amid Middle East supply vulnerabilities — policymakers are managing a tight balancing act between sticky inflation and the rising fiscal cost of debt servicing. Institutional strategists argue that Chair Kevin Warsh is likely to deliver a hawkish message, keeping the Greenback supported against major peers.

Rising yields and energy-driven inflation force Fed trade-offs

According to Lloyd Chan at MUFG, the surge in US Treasury yields across the curve reflects persistent inflation anxieties sparked by global commodity shocks. While escalating Middle East geopolitics and $100+ crude Oil strengthen the case for monetary tightening, the central bank must balance price stability against rising borrowing costs for the federal government and key domestic sectors.

"The US 10y Treasury yield has now reached 5.00%, while the 2y yield climbed to 4.66%... Market attention now turns to the FOMC meeting decision later today. Markets are pricing more than a 90% probability of a 25bps Fed rate hike, while expecting a cumulative two hikes by year-end. That said, the Fed faces a difficult trade-off... On one hand, inflation risks remain elevated, with Brent crude holding above US$100/bbl... On the other hand, tighter monetary policy raises debt servicing costs for the US government and adds further strain on interest-rate-sensitive sectors such as housing."

Hawkish Fed message and elevated Oil prices back US Dollar upside

Taking a pro-USD stance, Francesco Pesole and Frantisek Taborsky at ING assert that the Federal Reserve has little choice but to maintain a hawkish posture to reassure bond market participants. With energy prices threatening to push Oil higher toward $110/bbl, Chair Kevin Warsh's press conference is expected to keep the door open to additional rate increases, creating a high barrier for US Dollar downside.

"Markets are fully expecting a 25bp hike to 4.0% today, and a surprise hold or strong dovish dissent could have a materially negative impact on the dollar... Openness to further hikes by Warsh can leave the dollar broadly supported... Incidentally, the external picture argues against building sizeable USD shorts at this stage. Brent is aiming for $110/bbl, as Iran-Gulf negotiations are delayed again, and softness in tech stocks is weighing on overall sentiment."

Based on the combined perspective of both institutions, the US Dollar remains in a strong tactical position anchored by 5.00% long-end Treasury yields and elevated global energy prices. While MUFG underlines the macro trade-offs constraining the Federal Reserve's long-term trajectory, ING projects that a standard 25 basis point hike combined with hawkish guidance from Chair Warsh will deter bearish greenback bets and preserve the Dollar's upward momentum.

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