Dollar Holds Near Multi-Week Highs as Fed Rate Decision Looms

The dollar held near multi-week highs against several major currencies on Wednesday, with traders positioning for the Federal Reserve to deliver what is expected to be the first of a series of US interest rate increases.

A quarter-point hike is almost fully priced in, with market odds at roughly 90%. Currency strategists suggest such a move would give the dollar only a modest lift, while a decision to hold rates steady could trigger a sharp fall of more than 1%.

Much attention will centre on the Fed chair's press conference. Should policymakers raise rates but play down the prospect of further tightening, the dollar could soften. The central bank is seen as needing to demonstrate resolve on inflation, which has been stoked by the conflict with Iran and the associated surge in energy prices. Some analysts question whether one or even two hikes would be sufficient to restore the Fed's credibility with markets.

The dollar advanced alongside rising yields overnight, gaining most against the yen and the New Zealand dollar. The kiwi touched a two-month low of $0.5749 in Asian morning trade, while the yen weakened to a one-week low of 155.43 per dollar. The euro hovered at $1.1535, not far from Monday's one-month trough of $1.1523, and sterling stood at $1.3470, just above a six-week low of $1.3464. The Australian dollar was steady at $0.7126.

Broader currency moves have been muted even as global bond yields climbed in tandem, because sovereign debt has shifted in concert without sharply altering relative yield gaps between countries. The dollar has nevertheless found firmer footing in recent sessions.

The Fed decision carries particular weight for the yen, which is in the midst of its most promising rally in months. The recovery has been driven by a hawkish shift in expectations for Japanese rates, joint intervention by Japan and the United States, and talk of Japanese investors repatriating capital.

Markets see an 80% chance that the Bank of Japan raises rates on Friday, according to LSEG data, and have priced in two quarter-point increases by the end of January. One economist noted that the yen's path will depend heavily on interest rate differentials, adding that forecasts for the dollar-yen pair were recently revised to 155 amid scepticism that the central bank can match the pace of tightening markets expect. Political preference for low rates during ongoing fiscal expansion remains among the uncertainties.

Elsewhere in Asia, South Korea's won has surged more than 15% against the dollar since the end of June, buoyed by repatriated capital and profits from chipmaking giants. China's yuan has also stood out, holding its gains around 6.71 per dollar even as the yield gap between China and the rest of the world widens.