The US dollar retained most of its post-FOMC advance after the Federal Reserve lifted the fed funds rate by 25bps and signalled further tightening. Fed projections point to gradual disinflation, with the year-on-year core CPI rate reaching the 2% target only in 2029, while the long-run rate is marked higher; however, markets had already leaned towards a more hawkish outcome.<\/p>\n\n
The median dot plot shows 4.125% for both 2026 and 2027, implying another hike, then no cuts until 2028 when it slips by 25bps, followed by a further 25bps decline in 2029 to 3.625%. US Treasury yields had moved earlier, with bigger gains on 10 September than after the meeting, and the OIS curve had been priced for more than the two hikes implied by the 2026 median dot. Elsewhere, expectations for tighter policy include two further ECB moves to 3.00% and two additional BoE hikes, while the BoJ is expected to quicken tightening; across G10, only the SNB is not priced to hike by year-end. Front-end 2-year swap spreads point to limited further dollar demand, except in USD\/JPY.<\/p>\n\n
We advise derivative traders to avoid chasing the US Dollar’s post-FOMC rally, as the room for further upside is highly restricted. While the Federal Reserve’s recent 25-basis-point hike and hawkish tone initially boosted the greenback, this policy tightening was already heavily priced into the swaps market. In fact, Secured Overnight Financing Rate (SOFR) futures are already reflecting a terminal rate of around 4.25% for this cycle, leaving very little room for bullish surprises.<\/p>\n\n
We should look instead to other major currencies where central banks are actively catching up with their own rate hikes. For instance, we expect the European Central Bank to push its deposit rate to 3.00% with two more hikes, while the Bank of England is also poised to tighten further. This narrowing rate differential means the euro and sterling will likely find strong support against the dollar in the coming weeks.<\/p>\n\n
To exploit this environment, we recommend focusing on currency pairs with narrowing yield spreads rather than buying the US dollar broadly. The 2-year US-Germany yield spread has already compressed to around 165 basis points, down from over 200 basis points earlier this year, which historically limits USD strength. Trading Euro call options or establishing long EUR\/USD positions on short-term dips seems like a highly viable strategy.<\/p>\n\n
The clear exception to our neutral dollar outlook is USD\/JPY, where the interest rate differential remains wide enough to support further dollar gains. Even if the Bank of Japan pushes its key rate up toward 0.75% this year, the 10-year US Treasury yield still holds a massive 300-basis-point premium over Japanese equivalents. Derivative traders can exploit this by utilizing USD\/JPY call options to capture steady upside while hedging against sudden central bank interventions.<\/p>\n\n\n\n