Fed on deck with a rate hike expected

USD

The dollar extended higher yesterday, with the DXY rising 0.2% to trade around 99.6, as haven demand and tightening expectations reinforced each other, despite a modest cooling in oil prices after Monday’s rally. Looking forward, today is decision day, with all eyes on the Fed. We expect the FOMC to hike 25bps to 3.75-4.00% at 19:00 BST, an outcome markets price at roughly 90%. If delivered, market reaction will likely hinge on the vote split, the 2027 dots, and Chair Warsh's press conference at 19:30. But as we warned in our week ahead, a surprise hold risks an ugly sell-off in both Treasuries and the dollar on debasement fears. While not our baseline view, we think market pricing understates the risk of such an outcome, keeping us cautious ahead of the announcement later. Before then, August retail sales at 13:30 BST should show whether consumers rebounded from July's 0.6% slump.

EUR

The euro remained under pressure yesterday, slipping around a tenth against the dollar as Tuesday's ZEW surveys did little to help the single currency. German economic sentiment rose to just 34.7, short of the 40 expected, and the eurozone-wide gauge slumped to 25.8 from 31.4, underlining how the energy shock from the Middle East conflict is souring the bloc's outlook. With the eurozone calendar light today, the euro trades hostage to the Fed and oil headlines, and we think risks remain tilted to the downside while Hormuz stays shut.

GBP

Sterling softened modestly on Tuesday after softer-than-expected wage growth and hiring numbers, with GBPEUR retreating from the 1.17 level. This morning's CPI print has helped compound that downside pressure despite headline inflation rising to 3.1% in August from 2.9%, driven by fuel costs and airfares. Crucially, services inflation remained unmoved at 3.4%, a tenth below market expectations. That should be enough to keep the MPC from a hold at 3.75% tomorrow, in line with our week-ahead expectations, leaving the pound vulnerable as the Fed and ECB tighten while the BoE stands pat. Granted, the vote split will be key, with three members having backed a hike at the previous meeting; a larger hawkish contingent, albeit not our base case, would offer sterling some support. Today, though, the pound is likely to trade primarily off the Fed, with a hawkish outcome risking a retest of this week's lows in cable.

CAD

The loonie underperformed again yesterday, with USDCAD climbing to the mid-1.39s, extending its recent rally. Notably, crude's strength is providing little shelter: US trade tensions continue to weigh on Canada's outlook, while Monday's CPI report gave the Bank of Canada nothing new, with headline inflation steady at 3.0% and core measures anchored near 2%. As we argued in our reaction to that release, the data offers no case for an October move, and we continue to expect the policy rate to stay at 2.25% into 2027. With markets still attaching meaningful odds to an October 28th hike, we see that pricing as too aggressive, and its unwind should keep the loonie on the back foot. With no domestic data today, the FOMC is the main event, and a hawkish hike could see USDCAD test 1.40.

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