Dollar Holds Firm as Yen Nears Seven-Month Peak Before Fed and BOJ Calls

The dollar traded steady on Monday while the yen clung to recent sharp gains, hovering close to a seven-month high, as investors positioned for pivotal monetary policy decisions from the Federal Reserve and the Bank of Japan later this week.

Policymakers globally are navigating uneven price pressures stemming from the six-month-old US-Israeli war on Iran, which has driven oil prices well above $100 a barrel and unsettled the interest-rate outlook amid periodic selloffs in long-dated government bonds.

The European Central Bank raised rates last week and signalled more tightening could follow, setting the stage for the Fed's decision on Wednesday and an expected rate increase from the BOJ on Friday. The Bank of England is seen holding rates steady on Thursday, though the vote is likely to be close.

Expectations for a Fed hike strengthened after Friday's data showed US consumer prices accelerated in August. Markets priced an 86% probability of an increase this week and another move later in the year, according to the CME FedWatch tool.

"The Fed could decide to wait, but that is complicated by its October meeting being just ahead of the US midterm elections and waiting until December to move will be too long," said Shane Oliver, chief economist and head of investment strategy at AMP.

The euro stood at $1.159, while sterling was last at $1.3524. The dollar index, which tracks the greenback against six major currencies, was steady at 99.15 after two consecutive weeks of modest declines.

US Treasury yields remained near multi-year highs. The two-year yield, which typically tracks Fed rate expectations, eased slightly to 4.6148% after climbing 26 basis points last week.

Rising yields and shifting rate expectations have so far failed to lift the dollar, as major central banks are also expected to tighten policy and questions linger over the Fed's policy credibility.

"We think the dollar would welcome a hike in that it would back up the Fed's monetary policy credibility and take a little more steam out of the debasement trade," ING analysts said in a note. "Yet the dollar does not need to rally too far. After all, we think this is a recalibration of Fed policy, not a new cycle."

Brent crude futures rose nearly 3% to $107.51 a barrel in early Asian trading after fresh Houthi strikes on Saudi Arabia and Iranian attacks on ships in the Gulf compounded supply concerns following the closure of a key Saudi oil pipeline.

Yen faces BOJ test

The Japanese yen was at 153.49 per dollar, not far from the seven-month high of 152.89 touched last week, as fresh signs emerged that market sentiment on the currency is shifting, with speculators turning net long on the yen for the first time since February.

"A 25 bps hike is already almost fully priced," analysts at MUFG said in a note. "For the yen to strengthen further, the BOJ will have to signal that they are planning to stick to the faster pace of hikes."

TD Securities analysts said not putting another rate hike on the table for either the October or December meeting risks a knee-jerk dollar/yen rally back to 157 to 160.

The yen is up 4% this month on expectations that the BOJ will deliver rate hikes more quickly and on signs of potential repatriation of assets by domestic investors.

"Not hiking would be a catastrophic error. Not communicating robustly will be a significant own goal," said James Athey, fixed-income portfolio manager at Marlborough, adding that expectations about repatriation and GPIF asset allocation changes are playing a significant role in the yen's move.