Fed Tightening Cycle: Dollar Strength Not Guaranteed

Markets widely expect the Federal Reserve to begin a meaningful tightening cycle on Wednesday, following the recent shift from pricing multiple rate cuts to hikes. However, history suggests that this does not necessarily guarantee dollar strength in the wake of the Fed's first hike.

The US 2-year Treasury yield typically rises after the first hike of a cycle, and front-end rates have already moved in anticipation of tighter policy. But the performance of the US dollar has varied sharply across tightening cycles, with significant dispersion in its behavior following the first hike.

Heading into this likely cycle, DXY correlations sit near historical extremes, with the current relationship between DXY and front-end US rates being unusually tight. This correlation captures how the two have moved week to week, not their cumulative performance over the period.