USD/JPY could be caught in the crossfire of FOMC, BOJ: The Week Ahead

With a key US inflation report being delivered less than six hours ahead of an FOMC meeting, it leaves plenty of potential for volatile swings leading into the headline event of the week. And as the FOMC meeting includes updated staff forecasts, dot plot alongside the usual statement and then a press conference, it could make for a lively end to the session. The Bank of Japan also announce their monetary policy decision, and whilst not change is expected is should be remembered that this is a central bank that likes to catch markets off guard.

The week ahead (calendar):

The week ahead (key themes and events)

• US inflation (CPI, PPI)
• Fed interest rate decision, FOMC forecasts
• BOJ interest rate decision

US inflation (CPI, PPI)

With markets pricing in a September cut, traders will want to see further softening in the CPI data to justify their views. Even a slightly soft print might be enough to weaken the USD dollar and trigger a risk-on rally, considering how markets reacted after last month’s report.

Headline data mostly came in as expected, although traders focused on the -0.3% m/m print that fell below the 0.4% expected and previously, leading to a repricing of a September cut. To be fair, retail sales also came in at 0% compared with 0.4% expected. Still, this clearly weakened the US dollar and supported risk appetite, with Wall Street indices and commodities rising.

However, with the FOMC meeting just hours after the CPI report, if CPI fails to soften, it could spark last-minute panic among traders, sending the dollar higher along with yields and weighing on risk.

Trader’s watchlist: EURUSD, USD/JPY, WTI Crude Oil, Gold, S&P 500, Nasdaq 100, Dow Jones

Fed interest rate decision, FOMC forecasts

No change in policy is expected at this meeting, so it all comes down to how, or even if, they shape expectations for a potential September cut. With a fresh set of inflation figures at hand, this could tip the scales as to whether the Fed signals a cut in September or not. In all likelihood, I suspect they will.

The interest rate decision will be announced alongside the usual statement, but we also have updated FOMC forecasts to look forward to. As per usual, we will look for any changes to the Fed funds rate, PCE inflation outlook, and dot plot to decipher the likelihood of a cut at future meetings. Should they lower their median estimate for the Fed funds rate this year, that could be as good as a cut itself.

Traders should account for the usual knee-jerk reaction we see around the "decision" itself (despite no change expected), before the real move kicks off as investors digest the updated forecasts.

The dust will then likely settle for Jerome Powell's speech 30 minutes later, where he can truly shape market expectations if the initial communications didn't do the trick.

Trader’s watchlist: EURUSD, USD/JPY, WTI Crude Oil, Gold, S&P 500, Nasdaq 100, Dow Jones

BOJ interest rate decision

Japan's data has been a little mixed of late, with industrial production producing negative numbers while retail sales surpassed expectations. Tokyo's inflation rose back above 2%, which provides the likely direction of national CPI. These figures may not be enough to force the BOJ into action this week, but as stated many times before, one should never drop their guard on a central bank like the BOJ, which likes to catch markets off guard. Besides, markets are now pricing in a 10bp hike in July and September according to Bloomberg’s calculations. Overall, the data continues to build the case for policy normalization; the question is whether we'll get any timing clues at this meeting.

Trader’s watchlist: USD/JPY, AUD/JPY, GBP/JPY, EUR/JPY, Nikkei 225

USD/JPY technical analysis:

USD/JPY is on track to snap a 2-week winning streak with a bearish engulfing candle on the weekly chart, which would also be part of an evening star formation pattern. And USD/JPY could face further selling pressure should the Fed signal a cut, with the downside accelerating should the BOJ surprise with a relatively hawkish meeting.

Unless we see a surge in US dollar strength, next week’s bias is to fade into rallies below 157 in anticipation of a move down to 152 in the coming weeks.

-- Written by Matt Simpson

Follow Matt on Twitter @cLeverEdge