The Dollar is trapped: the rate hike is already priced in

GBP/JPY

Key zone: 208.00 - 210.00

Buy: 210.50 (on a confident break above 210.00); target 213.50-215.00; StopLoss 209.80

Sell: 208.00 (on strong negative fundamentals) ; target 204.50; StopLoss 208.70

A rate hike is not enough for a new USD rally. The monetary regulator approaches the September 16 meeting with CPI at 3.4%, PPI at 5.4%, unemployment at 4.1%, and the 10-year Treasury yield near 5%. A 25 bp rate hike has been almost fully priced in by the market.

Today, the Fed has a rare combination of factors supporting policy tightening: inflation remains significantly above the target level, the energy shock is intensifying price pressures, while the labor market is not yet showing a sharp deterioration. Therefore, a 25 bp rate hike from the current level to the 3.75–4.00% range has become the market’s base-case scenario.

A reminder:

The FOMC decision itself is already ceasing to be the main driver. If the Fed delivers exactly what the market expects, the USD may not receive any additional momentum. The focus will be on whether the September hike becomes the first step in a new cycle or a one-off adjustment.

Markets will pay particularly close attention to Warsh’s signals regarding the future path of rates.

• August CPI confirmed that price pressures in the U.S. remain uneven.
• Headline CPI rose by 0.4% m/m and 3.4% y/y. At the same time, gasoline prices increased by 3.9% over the month and accounted for more than one-third of the index’s total monthly increase. This is an important detail: a significant part of the acceleration in headline inflation is linked to energy.
• Core CPI excluding food and energy looks significantly calmer: +0.3% m/m and 2.4% y/y. This is the lowest annual core inflation rate since the spring of 2021. Thus, underlying price pressure remains noticeably weaker than the headline figure.
• However, PPI gives the Fed an additional reason not to rush into easing. The Producer Price Index rose by 0.4% m/m in August and by 5.4% over the year. The acceleration in the energy component is particularly notable: prices for final-demand energy rose by 4.2% over the month, while diesel fuel prices increased by 24.1%.

In other words, the Fed is seeing two inflation pictures simultaneously. Underlying pressure remains relatively controlled, but the energy shock creates the risk of a renewed acceleration in the headline index and the pass-through of producers’ costs into consumer prices.

The labor market is not yet forcing the Fed to rescue the economy. In August, the U.S. economy added 162,000 jobs, while unemployment remained at 4.1%. At the same time, the July figure was revised to just 21,000 jobs. After the release of the August data, average monthly job growth over the past 12 months stood at around 50,000, not 31,000 as stated in the original text.

Therefore, the balance of risks for the FOMC now looks different from the classic “inflation versus recession” scenario. The Fed can raise rates while continuing to monitor the economy, without responding to an obvious employment crisis.

Treasuries are already speculating on the idea of a tough Fed policy. The main problem for dollar buyers is that the bond market has already done a significant part of the regulator’s work.

According to the Fed, the yield on 2-year Treasuries stood at 4.65% on September 15, while the 10-year yield was 4.97%. The real yield on 10-year TIPS reached 2.60%. On September 8, these figures were approximately 4.39%, 4.80%, and 2.43%, respectively.

So, What Does This Mean?

There are two fundamentally different scenarios for the dollar.

• If the new dot plot and Warsh’s rhetoric allow for further rate hikes, the current level of Treasury yields will receive fundamental confirmation. In that case, the USD’s advantage may persist, especially against low-yielding European currencies and the pound.
• If, however, the hike is presented as a one-off adjustment and further steps prove to be fully data-dependent, the market may begin reducing long dollar positions. In this case, falling yields will become the main signal, while EUR/USD and GBP/USD will gain room for a corrective move higher.

For GBP, the situation is further complicated by the BOE meeting on September 17. If the Fed raises rates while the BoE keeps the Bank Rate at 3.75%, the relative divergence in monetary policy could increase pressure on GBP/USD. However, opening large directional positions immediately before the FOMC decision is risky: even a small divergence between the rate decision and Warsh’s wording could trigger a sharp move in yields and currencies.

Therefore, opening large USD positions immediately before the FOMC carries an unfavorable risk/reward ratio.

So we act wisely and avoid unnecessary risks.

Profits to y’all!