US Dollar: Fed pricing creates asymmetric risks – BBH

Brown Brothers Harriman’s (BBH) Elias Haddad says the US Dollar (USD) remains supported by energy-driven risk aversion ahead of the FOMC decision. With markets already pricing substantial Fed tightening, he sees asymmetric risks for USD, with limited upside from a hawkish outcome but greater downside from a dovish surprise. Haddad adds that current US economic conditions do not warrant an aggressive tightening cycle.

Fed path shapes Dollar outlook

"USD is holding on to this week’s gains, triggered by energy-shock risk aversion. The slump in bonds and stocks stabilized as the overshoot in crude oil prices stalled. Worrisomely, Iran has every incentive to keep the heat on ahead of the November 3 midterms and hurt Republicans."

"For now, all eyes are on today’s FOMC decision (7:00pm London, 2:00pm New York). The FOMC is poised to deliver a 25bps hike to a target range of 3.75%-4.00% after five straight holds, marking its first hike since July 2023. Persistently above target US inflation and a stable labor market justify a rate increase."

"Fed funds futures price in 94% odds of a hike today. As such, the vote split, updated Summary of Economic Projections, and Fed Chair Kevin Warsh’s press conference will guide the market reaction."

"The swaps curve already implies almost 100bps of tightening over the next twelve months: 25bps today, another 25bps hike by year-end, and nearly 50bps by September 2027. This creates an asymmetric risk for USD with limited gains from a hawkish outcome, but greater downside from a dovish surprise."

"In our view, the US economy does not warrant an aggressive tightening cycle. The slowdown in wage growth is disinflationary, and Fed policy is already somewhat restrictive against a nominal neutral rate of around 3.00%."