Dollar firms ahead of Fed as traders eye surprise rate hike

The U.S. dollar strengthened on Wednesday, holding near a one-month high as investors awaited the Federal Reserve’s interest-rate decision, with some analysts expecting policymakers to deliver a surprise rate hike.

The Dollar Index hovered around 101.20, down 0.06%, holding close to its highest level in four weeks as currency desks braced for the conclusion of the Fed’s two-day monetary policy meeting later in the day.

Trading across major currency pairs was characterized by cautious rangebound price action. The euro edged slightly higher to trade around $1.139 after bouncing off a one-month low in the previous session. Sterling was similarly subdued, hovering near its lowest levels since early July ahead of the Bank of England’s rate decision later in the week.

The dollar’s underlying strength comes as renewed hostilities in the Middle East lifted oil prices after joint U.S. and Saudi airstrikes targeted Iran-backed groups in Iraq, hours after the U.S. military said it had thwarted a surprise Iranian attack on American troops in the region.

Joint U.S. and Saudi airstrikes on Iran-backed groups in Iraq and subsequent Iranian missile launches sent crude prices jumping over 3%, threatening to reignite energy-driven inflation.

Despite the geopolitical tensions, currency markets remained largely subdued as investors stayed on the sidelines ahead of the Federal Reserve’s policy decision, with markets pricing in about a 36% probability of a 25-basis-point interest-rate hike.

"Markets remain divided over whether Fed Chair Kevin Warsh will validate recent dollar strength after investors accumulated long dollar positions on expectations that higher oil prices could keep inflation elevated," said Philip Wee, senior FX strategist at DBS.

"However, there is a risk those positions could unwind if the Fed fails to deliver a sufficiently hawkish message or signal another rate increase in September."

Focus across European foreign exchange desks will quickly pivot after the Fed decision, with both the Bank of England and the Bank of Japan scheduled to deliver policy updates later in the week.