Dollar rises ahead of pivotal Fed rate decision, sterling slips as UK CPI heats up

The U.S. dollar on Wednesday ticked up a sixth straight day, as currency market participants geared up for the first anticipated Federal Reserve interest rate hike in over three years. Meanwhile, the sterling slipped after government data showed an acceleration in consumer inflation in August. 

At 12:45 ET (16:45 GMT), the U.S. dollar index, which tracks the greenback against a basket of six major peers, rose 0.1% to 99.69. 

Pivotal Fed decision, eyes on dot plot and Warsh conference 

The Federal Open Market Committee (FOMC) is expected to raise the federal funds rate by 25 basis points. It would be the central bank’s first hike since July 2023, and the first move of any kind on monetary policy since a quarter-point rate cut in December last year. Higher rate environments tend to strengthen the dollar.

Coming into Wednesday’s Fed decision, rate hike expectations had been steadily building, partly on the back of U.S. economic data that pointed to resilient growth, a strong labor market, and elevated inflation. The latest reading on the central bank’s preferred inflation gauge, the personal consumption expenditures (PCE) price index, showed a 3.7% Y/Y increase, well above the Fed’s long-term 2% target. In fact, the PCE has remained above the 2% level for 65 straight months.

Perhaps even more so than the economic data and a resurgence in oil prices amid a widening conflict in the Middle East, the U.S. bond market has played the biggest part in boosting rate hike expectations. Bonds, especially longer-term maturities, have been gripped in a relentless sell-off roughly since the Fed’s July meeting, leading to a surge in Treasury yields to multi-year and multi-decade highs.

The bond rout began when three regional Fed presidents dissented with the FOMC’s move to hold rates steady in July and called for a hike instead, suggesting that fixed-income traders were unhappy with the central bank’s efforts to combat inflation. The rout then picked up steam in August amid spiking oil prices, concerns over the billions of dollars being poured into the artificial intelligence infrastructure buildout, and ballooning U.S. fiscal debt.

On Tuesday, the U.S. 10-year yield, which is used as the benchmark for everything from mortgages to corporate debt to student loans, hit its highest level since April 2007, while the 30-year yield took out a fresh high of over 24 years.

The question for currency markets now is whether today’s anticipated rate hike would be a "one-and-done" deal or whether it would be the start of a tightening cycle. As per the CME FedWatch tool, market participants expect at least one more quarter-point move this year. Against this backdrop, the Fed’s updated Summary of Economic Projections will be closely watched for the outlook on monetary policy.

Attention is also on Fed Chair Kevin Warsh’s post-decision press conference. Traders will be keen to see whether Warsh will signal any further cues on rates or if he will continue to reject providing forward guidance. Warsh sounded decidedly hawkish in his last public speech at the Jackson Hole conference in August. There is also political pressure on Warsh and the Fed to lower interest rates, most notably from President Donald Trump.

"The Federal Reserve is under pressure from the bond market to hike rates, as it’s not customary for the Fed funds rate to remain this far below where bond yields are trading," Brent Wilsey, chief investment officer at Wilsey Asset Management, said.

"If the Federal Reserve were to keep rates steady Wednesday, that could surprise...and surprises are rarely received well in markets, and it could also damage the Fed’s credibility, and reignite concerns that the central bank is caving to political pressure to keep rates steady," he added.

Annual UK CPI growth hits highest since March 

Turning to other major currencies, the sterling was in focus on Wednesday, shedding 0.2% to $1.3447.

Earlier, the United Kingdom’s Office for National Statistics reported a 3.1% Y/Y rise in the consumer price index (CPI) in August, up from July’s 2.9% reading and the highest since a 3.3% number in March. On a monthly basis, CPI increased 0.5% compared to July’s 0.3%. 

Transport prices, particularly motor fuels, made the largest upward contribution to the annual CPI rate, reflecting spiking global oil prices from the ongoing Middle East conflict. In a slightly more positive sign, UK’s core CPI in August gained 2.6% Y/Y, flat from July.

The inflation data comes a day ahead of the Bank of England’s interest rate decision, where it is largely expected to stay pat. However, swap traders now see a one-in-three chance of a quarter-point rate hike, with another move largely discounted before the end of the year.