Yen May Rise as Aussie Dollar Weakens on FOMC Pre-Positioning

Talking Points:

• Major currencies treading water vs. US Dollar amid lull in major event risk
• Risk aversion may weigh on commodity bloc FX, boost Yen as FOMC looms
• Fed unlikely to raise interest rate but may ramp up hawkish tone in rhetoric

FX markets are in digestion mode at the start of the trading week, with the major currencies little-changed against the US Dollar. Asian stock exchanges are pushing higher but the move seems to reflect reactionary flows to Friday’s upward push on Wall Street rather than new optimism.

The economic calendar is relatively quiet in the hours ahead, hinting the relative quiet is likely to continue. Pre-positioning for the FOMC policy announcement – the top event risk for the week – may open the door for a cautiously risk-off mood as the day progresses. Chair Yellen and company are widely expected to keep rates unchanged but may offer commentary that clashes with investors’ dovish posture.

Policymakers have made significant progress on achieving their mandate. The unemployment rate is at 4.9 percent, the lowest since January 2008, and the Fed’s favored Core PCE measure of inflation hit 1.7 percent in January, a hair below the target 2 percent. A drop in the US Dollar and a rebound in oil prices in February have likely pushed the price growth gauge even further in the right direction.

This gives the Fed compelling reasons to tighten, but officials will need to bring their outlook closer in line with that of the markets if they hope to avoid another round of destabilizing volatility across the asset class spectrum. This means the FOMC will have to fine-tune its language to convincingly signal on-coming stimulus withdrawal and push investors to acclimate.

Worries about such an outcome may weigh on sentiment, capping gains in the risk-linked Australian, Canadian and New Zealand Dollars while weighing on equityand gold prices. Funding currencies like the Japanese Yen may edge higher in this scenario. The Fed signaled four rate hikes for 2016 in December. The markets expect just one based on the current priced-in consensus.

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--- Written by Ilya Spivak, Currency Strategist for DailyFX.com

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