FX Update: FOMC must deliver on market expectations at minimum.

FX Trading focus: FOMC expectations and the reaction function. BoE important tomorrow.

I am expecting the Fed to hike 50 basis points today and for Chair Powell to indicate in the Q&A that there is the possibility of a 50 basis points “or greater” at coming meetings (the “s” important there) . I expect the Fed will guide as expected on quantitative tightening to ramp up to the $95 billion/month pace over the summer (NOT waiting until Labor Day in September) with guidance for future fine-tuning reviews. The Fed is least comfortable with its understanding of QT impacts and won’t want to surprise on that front by much for now).

In general, a hawkish surprise could raise the front end of the yield curve ever so slightly. I could be wrong at the margin in leaning for far higher odds of a hawkish surprise. An alternative scenario could be Powell simply making a blanket comment that he refuses to comment specifically on the size of coming hikes, but that they will be appropriate to the circumstances (in a way that could be read as even more potentially hawkish). Regardless, the conviction comes as it is far too early for the Fed to not at least signal that it is willing to do what the market expects for the coming few meetings and odds are not small that the Fed goes ahead with 75 basis points today (favourite scenario still at 62.5-bp hike to get the rate to 1.00% and ditching the upper/lower bounds that are irrelevant when policy isn’t close to zero). The market is pricing high odds that at least one of the following two FOMC meetings will see a larger than 75-basis point move. As for the USD reaction, that will depend on the pair, but the only way I can see tonight as USD negative is if the market is leaning even harder for more Fed hawkishness than what the Fed delivers – and I am not seeing signs of that. the most supportive for the US dollar would likely be a further lifting of US yields all along the yield curve – for more thoughts on that, consider the USDJPY chart discussion below.

Chart: USDJPY
USDJPY will focus squarely on the long end of the US yield curve in all likelihood on the back of tonight’s FOMC meeting. If Powell and company surprise significantly to the hawkish side, it won’t necessarily spark a durable rally higher in USDJPY if long US treasury yields don’t follow suit, as discussed above. Ergo, the only likely path lower for a more pronounced USDJPY sell-off would be on a sharp jerk lower in long US yields on the assumption that the Fed is getting ahead of the inflation risk and that the policy tightening priced in for the next few quarters will lead to an inflation-crushing softening of the economy. Probably the most bullish development for the pair, on the other hand, would be a Fed that generally fails to surprise expectations much and sees US longer yields rushing to new cycle highs. Momentum is slightly divergent – but that setup would likely only find confirmation on US treasury yields in steep retreat post-FOMC and a move and close below perhaps 128.50 to start.