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USD/JPY Dives Post-BOJ; Preview for September FOMC Meeting

USD/JPY Dives Post-BOJ; Preview for September FOMC Meeting

Christopher Vecchio, CFA, Senior Strategist

Talking Points:

- BOJ refrains from major easing, only small technical adjustments.

- USD/JPY reverses quickly ahead of FOMC later today.

- FX volatility set to remain high with FOMC and Brexit vote next two weeks - it's the right time to review risk management principles to protect your capital.

Here we go again: What once was a much heralded and anticipated rate decision, the September FOMC meeting seems all but wrapped up at this point. The Federal Reserve will keep its main rate on hold at 0.25-0.50%, citing near-term, weak economic developments, yet insisting that enough progress has been made to warrant a rate hike at one of the upcoming meetings (hint: December, when the next SEPs are released). The key for the US Dollar today, however, is to what degree of confidence the FOMC has in the US economy, or simply, 'how quickly does the Fed think it will be able to raise rates next?'

Certainly, market participants are looking around and don't see much to be excited about. As a gauge of long-term growth and inflation expectations, the US Treasury yield curve has flattened significantly over the past year. The evolution of US economic data over the past several months has, in investors' minds, reduced the potential for substantially higher interest rates in the long-run. If the US economy is close to moving to a recession, look for the yield curve to invert (2s10s spread) - an inversion preceded each of the last seven US recessions (every recession in the post-war era).

In December 2015, we pointed out the US yield curve was already starting to flatten out, which was the bond market's way of saying that long-term growth expectations weren't looking so hot. In turn, as this flattening has continued, market participants have reduced expectations for the Fed to tighten policy further (an expanded interpretation is that the Fed's insistence on raising rates despite the obvious shortcomings in the economy may significantly reduce the economy's long-run growth potential).

After the past few weeks of US economic data (US Citi Economic Surprise Index down from +43.1 on July 26 to +3 through yesterday), markets are only pricing in a 20% chance of a hike today, and a 55% chance of a hike by December. Over the past 20 years, the Fed has never raised rates unless the market has been pricing in the chance of a hike in excess of 60%, so in actuality, rate expectations are completely muted for today and are sitting on the fence for 2016.

This is the main source of risk for markets today. Should the FOMC choose to be headstrong and tear down conventional wisdom - a small possibility with two prime dealers coming out and calling for a rate hike - global markets will be shocked. But assuming the Fed plays it safe as it usually does, a lack of a rate hike may not hurt the US Dollar significantly. By suggesting that a rate hike is still "on the table" in the near-term, and by laying out an interest rate glide path for next year calling for multiple rate hikes, then the Fed could help insulate the US Dollar, plain and simple. It's starting to feel like a September-December 2015 redux.

See the video (above) for technical considerations in EUR/USD, GBP/USD, USD/JPY, AUD/USD, and the USDOLLAR Index.

Read more: US Dollar Off Day Before FOMC as Atlanta Fed GDPNow Forecast Falls

--- Written by Christopher Vecchio, Currency Strategist

To contact Christopher Vecchio, e-mail cvecchio@dailyfx.com

Follow him on Twitter at @CVecchioFX

To be added to Christopher’s e-mail distribution list, please fill out this form

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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