Fed Hike Expectations Boost Dollar, But Gains Remain Limited

The US Dollar has strengthened modestly in anticipation of a Federal Reserve rate hike at this week's FOMC meeting, but market participants are waiting for confirmation of policy action to unlock further gains. According to MUFG's Lee Hardman, the dollar index has risen above its 200-day moving average, supported by stronger US inflation data and a hawkish repricing at the short end of the US yield curve.

Hawkish repricing of Fed rate hike expectations has been priced in for this week's FOMC meeting, with 22bps of hikes currently expected compared to around 15bps last week. However, the positive impact on the dollar from these expectations has been surprisingly limited so far, with a mere 0.3% increase in the dollar index over the same period.

One reason for this limited gain is the uncertainty surrounding the Fed's willingness to address upside inflation risks, which could trigger a sharp sell-off if they fail to take action at this week's meeting. Additionally, market participants may be waiting for confirmation of policy action before opening up further gains for the dollar.