TD Securities expects the FOMC to start a hiking cycle at its September meeting with a 25bps increase, while the dot plot in the SEP may point to fewer hikes than markets are pricing. The team also anticipates upgraded inflation and labour market projections, after August inflation data showed a lack of progress, and expects the Chair to refrain from offering forward guidance.
With a 25bp hike almost fully priced in, the firm expects the dollar to show knee-jerk weakness under its base case, alongside a modest bull steepening of the curve. A hold would be a dovish surprise and could pull USD back to pre-August CPI levels, whereas a more hawkish dot plot — including the prospect of an October hike — could extend the recent USD rally.
FOMC Policy Expectations and Dollar Scenarios
We expect the FOMC to kick off a new hiking cycle at its upcoming September meeting with a 25-basis-point rate increase. This policy shift follows August inflation data that showed a stubborn lack of progress, which will likely force Chair Warsh to address these persistent price pressures. While this 25-basis-point hike is almost entirely priced into the fed funds futures, derivative traders must prepare for sudden volatility driven by the dot plot.
If the Fed delivers this rate hike but signals fewer future increases than the market currently projects, we will likely see a knee-jerk selloff in the US Dollar. To capitalize on this base case, traders should consider short-term put options on the Dollar Index (DXY) to capture a temporary dip. Conversely, a surprise rate hold would act as a massive dovish shock, potentially dragging the greenback all the way back to its pre-August CPI release levels.
Implications For Projections, Derivatives, and Yield Curves
We must also prepare for the risk of a more hawkish Summary of Economic Projections that upgrades both inflation and labor market outlooks. If the revised dot plot explicitly puts another rate hike on the table for October, the recent US Dollar rally will have room to extend much further. Under this hawkish scenario, securing long call options on the Dollar or utilizing bullish spread strategies would be the most effective play.
In the treasury market, we anticipate a modest bull steepening of the yield curve under our base case of a milder dot plot. Derivative traders should look to position for this steepening, especially since recent market repricing has already adjusted for the immediate rate hike. Monitoring the spread between the 2-year and 10-year Treasury yields will be crucial for timing these entry points over the coming weeks.
