US Dollar: Hawkish Fed may offer only limited gains - BBH

Brown Brothers Harriman’s (BBH) Elias Haddad expects the Federal Open Market Committee (FOMC) to deliver a 25 bps hike to 3.75%-4.00%, its first move since July 2023, justified by above-target inflation and a solid labor market. Futures already price further tightening, so market focus will be on the vote split, projections and Chair Warsh’s guidance, with clearly defined hawkish and dovish scenarios for the US Dollar (USD).

Hawkish and dovish policy paths

"The FOMC is poised to deliver a 25bps hike to a target range of 3.75%-4.00% on Wednesday after five straight holds, marking its first hike since July 2023. Persistently above target US inflation and a stable labor market justify a rate increase."

"Fed funds futures price in roughly 90% odds of a hike this week. As such, the vote split, updated Summary of Economic Projections, and Fed Chair Kevin Warsh’s press conference will guide the market reaction."

"The futures curve already implies almost 100bps of tightening over the next twelve months: 25bps this week, another 25bps hike by year-end, and nearly 50bps by September 2027. This creates an asymmetric risk for USD with limited gains from a hawkish outcome, but greater downside from a dovish surprise."

"Hawkish scenario: a unanimous or near unanimous vote for a hike, dots that align with markets, and/or Warsh signaling more tightening would lift USD."

"Dovish scenario: a split vote for a hike, dots below market pricing and/or Warsh framing the hike as insurance against inflation rather than the start of a sustained tightening cycle would weaken USD."

"In our view, the US economy does not warrant an aggressive tightening cycle. The slowdown in wage growth is disinflationary, and Fed policy is already somewhat restrictive against a nominal neutral rate of around 3.00%."