Fed Preview & Trading USD/JPY

Markets have been rattled by talk of an aggressive 50 basis point hike as soon as this month. If/when this doesn’t happen there is scope for a relief rally. Equally, the Fed sounding toothless in the fight against inflation could spark further risk aversion.

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According to the latest survey of economists, the Fed is expected to not change policy at today's meeting. But, following that, Chair Powell is likely to signal that a rate hike is imminent, which is generally understood to mean at the next meeting scheduled for March 16-17.

At the current wind-down rate of asset purchases, the Fed would finish its $8.8tn QE program in mid-March. The current program envisions a reduction that would end the program around the next meeting. This would be the fastest way for the Fed to complete tapering before raising rates.

More than one option on the table

Some analysts are hedging their bets by suggesting a slight chance that the Fed could outright announce a rate hike later today. Others speculate on whether the Fed could consider hiking twice in March. Markets must be prepared for any outcome as several policymakers turn more hawkish, making four or more hikes plausible in 2022 if inflation persists.

Can the flight to safety continue?

Recently, there has been a turn towards safe haven assets, given the rise in geopolitical concerns around Ukraine. This has only exaggerated the real yield differential between the safe-haven yen and the dollar.

Earlier in the month, the US 10yr nominal yield was trading at a 2-year high of 1.90% and -0.57% when adjusted for inflation. Japan's real rates were at 50-years low. Negative rates reflect the expansive monetary policy environment and likewise when they move closer to zero, expectations of ending accommodative rates – as is the case for the US.

A hawkish Fed could elevate nominal yields at the expense of the yen as there is a strong inverse correlation between the two. But that relies on the assumption that inflation will be curbed as a result. Many analysts expect inflation to peak in Q1 - evident in the US30yr yields rise.

USD/JPY Trajectory

USD/JPY is trending higher on the daily candlestick chart with support from a rising trendline at 113.5 then the December low at 112.5. However, RSI shows a bearish divergence with the rising trendline connecting the two most recent price peaks. Additionally, the most recent bounce of the lower rising trendline stalled at 115 resistance, suggesting a possible top and breakdown from the rising channel pattern.

Source: Spreadex Trading Platform

Key Takeaways

Hiking interest rates in January's meeting is unlikely, but Jerome Powell should provide markets with signals about its first hike and the steps the Fed is likely to take towards balance sheet normalization. The speed at which future rate hikes will come will determine the hawkish/dovish assessment from traders.

If the FOMC is hawkish, real yields might start getting closer to zero, posing a threat to stocks but also the yen, putting upwards pressure on USD/JPY. Equally, if the Fed is dovish, or even just matches expectations, USD/JPY could come under pressure.