USD Surges as Higher Yields Fuel Risk-Off Sentiment Ahead of FOMC

The US Dollar (USD) has strengthened ahead of the FOMC meeting as expectations of Fed tightening have been repriced higher. According to MUFG's Lee Hardman, rising US yields are supporting a risk-off tone in the market.

The US Dollar Index (DXY) has recovered to levels seen before the August Treasury buyback announcement, with US bond yields increasing sharply. While modest FX spillovers have been observed so far, emerging market currencies and high-beta assets face greater downside risks if bond yields and energy prices continue to climb.

The stronger US Dollar has been driven by a hawkish repricing of Fed rate hike expectations, with the market now anticipating almost 100bps of hikes in the year ahead. This marks a reversal of last year's rate cuts, which totaled 75bps. Measures of volatility in both equity and FX markets have started to pick up but remain at low levels.