Markets are relatively becalmed ahead of a Federal Reserve decision that could sustain—or reverse—a long rally in the dollar. Trading ranges for risk-sensitive currencies are narrowing, equity futures are pointing to a softer open, and US government bond yields are easing from yesterday’s highs – the 10-year closed at 3.571 percent and the two-year reached its loftiest levels since 2007 at 3.962 percent.

Commodity prices spiked higher last night after Russian President Vladimir Putin mobilized his country’s military reserve and threatened a nuclear response in Ukraine, saying, “Those who are trying to blackmail us with nuclear weapons should know that the wind patterns can also turn in their direction”. Both the West Texas and Brent global crude benchmarks added more than 3 percent, front-month European natural gas contracts climbed nearly 9 percent, and wheat shot up almost 4 percent.

The euro slumped back below parity after Putin’s address, and is struggling to gain traction as investors prepare for an escalation in the war. This could prove short lived – Russia’s mobilization of hundreds of thousands of untrained troops is unlikely to decisively turn the tide of war, the logic of mutually-assured destruction makes nuclear threats less compelling, and Europe remains motivated to bolster energy independence ahead of what could become a long, cold winter. We suspect the facts on the ground remain largely unchanged, relative to a few days ago.

The Canadian dollar remains sharply lower after yesterday’s softer-than-anticipated inflation data. Both headline and core price measures came in below expectations in August, lowering forecasts for Bank of Canada hikes and further widening yield differentials against the loonie. The currency is still doing better than most of its developed-market counterparts on a year-to-date basis, but downside risks are growing stronger as higher borrowing costs slam a spectacularly-leveraged private sector.

At this afternoon’s Fed meeting, markets are prepared for a 75 basis point hike and a repeat of the message delivered at Jackson Hole: that rates will move higher and stay there until inflation comes down on a sustained basis. Data in the last month has shown the US economy proving more resilient than expected, with the job market booming and consumer spending going from strength to strength – but there are storm clouds on the horizon as financial conditions tighten and leverage comes down across the banking system.

The “dot plot” included in the Statement of Economic Projections could prove more important for markets. The median expectation for rates in 2023–previously 3.8 percent, now likely to approach 4.25 percent—will help solidify terminal rate estimates for this cycle, and growth forecasts could quantify the Fed’s pain tolerance ahead of a potential downturn. If officials somehow manage to outhawk markets, yields could march higher, dragging the dollar along with them. More plausibly, a more dovish than expected outlook could see the dollar lose momentum.

Central banks in the United Kingdom and Japan are also set to announce their latest decisions. Most observers see the Bank of England delivering a 50 basis point hike, but a 75-point move is hardly unlikely, given a still-elevated inflation outlook. The Bank of Japan is expected to stand pat, maintaining its commitment to keeping 10-year government bond yields close to zero.

Karl Schamotta, Chief Market Strategist