The U.S. dollar has been under increasing pressure as markets anticipate a significant shift in monetary policy from the Federal Reserve. As the Fed's decision on a potential rate cut looms, the dollar traded near its lowest levels of the year on Tuesday, with investors betting heavily on an aggressive easing cycle that could begin with a substantial 50 basis point reduction.
In the lead-up to Wednesday's much-anticipated meeting, the euro rallied overnight, reaching $1.1138, close to its year-high of $1.1201 against the dollar. The yen, which has seen the most significant decline this year, briefly strengthened past 140 yen per dollar during Monday's holiday-thinned trade before easing back to 140.96 as Tokyo markets reopened. Analysts suggest that the yen, due to its substantial losses this year, has the most room to rally if the Fed adopts a dovish stance.
"Regardless of whether the Fed opts for a 25 or 50 basis point cut, we anticipate that the Fed's messaging will be 'dovish,'" noted strategists from Macquarie in a client note. They added that the U.S. dollar could weaken against major currencies even if the Fed opts for a smaller 25 basis point cut. The yen, in particular, is expected to benefit the most, given the stark contrast between the policy outlooks of the Fed and the Bank of Japan (BoJ).
The BoJ is expected to maintain its current policy stance at its meeting on Friday but could signal the possibility of future rate hikes, potentially turning October's meeting into a pivotal one. This divergence between the Fed and BoJ could further pressure the dollar, especially if the Fed signals a more extended easing cycle.
Sterling, which has been the best-performing G10 currency this year with a 3.9% gain against the dollar, also rose above $1.32 on Monday, buoyed by signs of resilience in the UK economy and persistent inflationary pressures. Early Tuesday, it was trading at $1.3209, with markets largely expecting the Bank of England (BoE) to hold rates steady at 5% during its Thursday meeting. However, there remains a 36% chance of a rate cut being priced in, reflecting the uncertainty surrounding global economic conditions.
The Australian and New Zealand dollars joined the rally against the greenback, trading at $0.6750 and $0.6192, respectively. These currencies, along with others, have been buoyed by market focus on the Fed's upcoming decision rather than the deepening troubles in China's economy, which continues to weigh on global growth prospects. Chinese markets remained closed for the mid-autumn festival break until Wednesday, but the offshore yuan was firm at 7.1000 as it settled into a new trading range.
The U.S. Dollar Index, which measures the greenback against a basket of major currencies, weakened by 0.4% overnight to 100.7, approaching its 2024 low of 100.51, recorded last month. This decline reflects the market's anticipation of the Fed's move, with investors adjusting their positions ahead of what could be a significant shift in U.S. monetary policy.
The outcome of Wednesday's Federal Reserve meeting will be critical in determining the dollar's trajectory. With markets now pricing in a 67% chance of a 50 basis point cut, compared to just 30% a week ago, the size of the Fed's rate reduction will likely dictate the dollar's near-term direction. A larger-than-expected cut could lead to further dollar weakness, while a more conservative move could offer a buying opportunity for traders betting on a rebound.
"All eyes are on the Fed's decision," said one analyst. "The size of the cut will be crucial, but perhaps more important will be the Fed's guidance on future policy moves."
In addition to the Fed's decision, U.S. retail sales data and Canadian CPI figures are expected later in the session, offering further insights into North American economic conditions. However, these releases are likely to be overshadowed by the Fed's meeting, which remains the primary focus for global markets.
