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Yesterday’s Bank of Japan decision versus market expectations ahead of today’s Fed conference

INVESTINGYesterday's Bank of Japan decision versus market expectations ahead of today's Fed conference

Yesterday’s interest rate hike by the Bank of Japan has drawn the market’s attention, but today the focus has shifted to the USA, indicating that the Federal Reserve, or the Fed, will soon be deciding on the cost of money. The market is wondering if we can expect anything more than a mundane press conference from Jerome Powell. It seems pretty clear that the Fed will not start cutting rates until June. Investors will now primarily focus on the new forecasts, as well as comments on recent inflation results.

In my opinion, the market will largely evaluate the new “dot plot.” December’s projection pointed to three rate cuts this year. If we see a change here, the dollar could react more decisively, as the market will be adjusting its valuation. Currently, Fed Fund Futures contracts indicate three downward moves this year, each by 25 basis points. Recent data on inflation and current economic conditions suggest that a “hawkish” Fed turn may be more likely. If the curve points to higher rates in the medium and long term, then the dollar could gain, and Wall Street could get an argument to start a more significant technical correction. Note that stock indices have been growing uninterrupted since the end of October. There were drops during this period, but their scale did not exceed 2.5 percent. The most significant downward correction we had last year, which began during the summer holidays. Since then, market moods have continued to show a high appetite for risk. Remember that since December, the Fed has become more cautious in relation to interest rate cuts. If such a scenario were to materialise, the EUR/USD could quickly find itself around the round level of 1.08 and simultaneously level out the lows from the end of February and early March of this year. If the scale of the surprise was greater, the next threshold is at 1.07 – the bottom established in the middle of last month. I assume that the risk of USD weakening during today’s events is real, but in my opinion, less likely.

Instead of strengthening after yesterday’s decision, the yen reacted in the opposite way, and thus, the USD/JPY exchange rate is back in a zone close to historical records this morning. This increases the risk of sudden currency intervention by the Bank of Japan or the Ministry of Finance. Recall that the Bank of Japan raised its main interest rate, thereby ending its negative interest rate policy. It also gave up control of the yield curve. However, it is unlikely that further steps will be taken quickly. This fact has caused the yen to lose value instead of appreciating, showing that recent market expectations have been greatly exaggerated.

Łukasz Zembik, Oanda TMS Brokers

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