Will the Dollar Fall if the Fed Doesn't Raise Interest Rates? ING Warns of Potential Reversal of Long Positions

ING warns that if the Federal Reserve (Fed) decides to keep interest rates unchanged, the dollar positions built by the market to guard against a rate hike may reverse, causing the dollar to follow the decline in oil prices again.

The Bloomberg Dollar Spot Index fell less than 0.1% on Wednesday (29th), marking the fourth consecutive trading day of near-flat performance, showing almost no reaction to recent volatile oil price movements. The 60-day rolling correlation between the dollar index and Brent crude oil futures has also fallen to its lowest level since the end of March.

ING strategist Francesco Pesole said the resilience of the dollar will face a major test after the Fed's decision is announced. If the Fed stands pat, investors may unwind the dollar long positions they built to guard against an unexpected rate hike, causing the dollar to once again reflect the signals from the decline in oil prices.

Data from the U.S. Commodity Futures Trading Commission (CFTC) shows that traders have been consistently bullish on the dollar this year, with current optimism towards the dollar at its highest level since 2015. After the U.S. launched an attack on Iran, global energy transportation was disrupted, pushing up international oil prices and raising concerns about potential runaway inflation, prompting the market to bet that the Fed would adopt a more hawkish monetary policy.

Despite the oil price volatility over the past six months of the U.S.-Iran conflict, the market has now fully priced in the possibility of a Fed rate hike in September. As for the Wednesday meeting, the rate swap market still sees maintaining the status quo as the baseline expectation, but estimates the probability of an immediate rate hike by the Fed at around 34%.

TD Securities also warned that if the Fed keeps interest rates unchanged, the dollar may fall, but the extent of the decline will depend on the voting results of the Federal Open Market Committee (FOMC) and how many officials advocate for a rate hike.

Kevin Warsh, who took over as Fed chairman in May this year, no longer clearly signals the direction of interest rate decisions in advance like past Fed chairs. ING believes that unless Warsh unexpectedly releases a hawkish signal or more than two dissenting officials vote to support a rate hike, the dollar may face downward pressure on Wednesday.