US Dollar holds firm on Fed policy outlook and geopolitical tensions, experts agree

• A three-day gain of 0.6% takes the US Dollar Index above 102.00 to new two-week highs.
• Expectations of a hawkish hold from the Fed on Wednesday draw investors back to the US Dollar.
• Fading prospects of an immediate US-Iran peace agreement lend further support to the safe-haven USD.

A rise of more than 0.6% over the past three trading days has taken the US Dollar Index (DXY) to two-week highs above 102.00. The index tracks the US Dollar (USD) against a basket of six other currencies. With the Federal Open Market Committee (FOMC) meeting outcome due next Wednesday, the US Dollar has ranked among the strongest major currencies in recent sessions.

Expectations that the Federal Reserve (Fed) will hold rates steady while retaining a hawkish stance have prompted traders to take long positions in the US Dollar this week. Markets are looking for confirmation of expectations for a quarter-point rate increase in December. Meanwhile, the latest effort to ease tensions in the Middle East has, like earlier attempts, come to nothing. Continuing skirmishes between regional powers and attacks in the Strait of Hormuz are also underpinning the USD’s appeal as a safe haven.

Dollar gains support as pivotal Fed decision approaches

ING’s Chris Turner expects central banks to retain a hawkish stance, citing “energy prices firm and expectations growing that the US and Israel will launch another attack on Iran (...) we expect central banks to stay hawkish. This should keep the dollar supported on dips.”

A similar assessment comes from analysts at HSBC, who "expect the USD to consolidate near its recent highs over the coming weeks, with risks tilted towards further gains rather than material weakness."

Nevertheless, HSBC favours a more neutral outlook for the USD. The bank’s experts argue that "US economic resilience, a hawkish Federal Reserve and potential challenges for other currencies should limit the USD’s downside, without necessarily providing the momentum for another leg higher."

Persistent inflation risks also lead TD Securities to forecast a cautious stance from the FOMC following Wednesday’s meeting. Its expert offers a similar view: “A hold in October will make a December hike all the more likely,” according to TD Securities.

Tighter Eurozone credit conditions bolster USD demand

The findings of October’s ECB survey are highlighted by strategists at Brown Brothers Harriman, who note that it “showed a further net tightening of credit standards and weaker loan demand in Q3”. They say this combination “is a headwind to Eurozone economic activity and challenges the nearly 75bps of ECB hikes priced by markets over the next twelve months.”

Turning to the US outlook, BBH says “September durable goods orders and ADP weekly employment change will likely underscore the resilience of the economy”. The firm also notes that “rising gasoline prices point to worsening near-term inflation expectations in October’s consumer confidence survey.” Taken together, these factors strengthen the argument for the Fed to maintain a firm monetary policy stance.