US Dollar Bulls Await FOMC as Japan's MOF Faces an Intervention Dilemma

The Federal Reserve's latest policy decision arrives at a pivotal moment for both the US dollar and USD/JPY. With the US Dollar Index pressing against its March high and speculative traders piling into bullish USD positions at the fastest pace in six years, a hawkish outcome could provide the catalyst for a fresh breakout. That would leave Japan's Ministry of Finance (MOF) facing an uncomfortable dilemma: intervene against a strengthening US dollar and risk fighting market momentum, or stand aside and watch USD/JPY push deeper into territory that has previously triggered intervention.

 

Source: LSEG​

 

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FOMC Meeting Tests the US Dollar as USD/JPY Nears Intervention Territory

Fed Expected to Hold Rates at Warsh's First Meeting

Kevin Warsh will chair his first FOMC meeting, so what he says during the press conference will be closely scrutinised, to say the least. It has also been speculated that he may not submit his own dot in the Summary of Economic Projections (SEP), either because he does not feel ready or simply does not like the process. Let’s hope that is not the case, as it would imply he is either underprepared for the role or not particularly transparent.

Fed funds futures imply near certainty that rates will remain unchanged today, with a 99% implied probability of a hold. The first move is expected to be a 25bp hike in December, although the probability currently stands at just 49%. The updated Summary of Economic Projections (SEP) could, of course, alter both the timing and odds of the next move.

I do not expect any significant changes to the statement or the Fed's overall tone, which is likely to remain hawkish given the strength of recent economic data and persistent inflationary pressures.

While inflationary pressures are expected to ease over time following the Middle East peace deal, it should be remembered that the US economy has thus far withstood elevated inflation. Moreover, some inflationary pressures are likely to linger for longer than previously anticipated.

 

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Dot Plot Holds the Key for US Dollar Direction

Any changes to the dot plot and Fed funds forecasts will be among the first details traders scrutinise. The March dot plot showed seven officials expecting rates to remain unchanged this year, while twelve anticipated cuts. Given that five policymakers projected at least two cuts, there is scope for a meaningful hawkish shift in this release.

The Fed has already revised its core PCE inflation forecast higher to 2.7% for this year, although there may be scope for a further upgrade. In short, the risks appear skewed towards a hawkish outcome from both the statement and the dot plot.

The bigger question is whether any officials now foresee a rate hike. Even if Warsh withholds his dot, a higher distribution of dots among the remaining participants could still provide support for the US dollar. Whether the US dollar can hold onto those gains will then depend on the hawkishness of Warsh’s press conference.

 

 

 

US Dollar Bulls Piled into the Futures Market Last Week | COT Report

Now is a good time to remember that US dollar futures traders were not holding back with their bullish bets, according to the latest Commitment of Traders (COT) report. Net-long exposure to the US dollar increased by $11.4 billion, marking the largest weekly rise in six years and taking total net-long exposure to $27 billion.

While positioning is elevated by recent standards, there is still scope for it to push above $30 billion. For context, net-long exposure exceeded $50 billion during the 2014 bull run. With a potentially hawkish FOMC meeting on tap and the US Dollar Index teasing a bullish breakout, the odds favour another influx of bullish USD bets.

Source: CME, IMM, CFTC (COT, LSEG)

 

For traders wanting a deeper understanding of futures positioning, I’ve also published a guide on how to read and interpret weekly COT data in forex markets.

 

FOMC Decision Puts USD/JPY and MOF Intervention in Focus

Naturally, if the US dollar rises, so too should USD/JPY — much to the annoyance of Japan’s Ministry of Finance (MOF). Given USD/JPY is already trading above the May 6 intervention level just below 158 and is close to retesting the April 30 high near 160.70, it is a safe bet that today’s FOMC meeting is firmly on the MOF’s radar.

Yet to some degree, their hands are tied. Trying to support the yen in the face of aggressive bullish US dollar bets would not be wise, as even the might of the MOF would be swimming against the tide. We have seen in the past that they prefer to strike during periods of low liquidity, and preferably when fundamentals are behind them. However, a hawkish FOMC meeting may not allow that. In that case, they may simply have to watch USD/JPY break higher while throwing in the occasional jawbone, even if it proves futile.

However, if the Fed delivers a less hawkish outcome than markets expect, it could ironically pave the way for intervention. In that scenario, the MOF could benefit from the bearish momentum generated by unwound US dollar bets.

 

Positioning Suggests USD/JPY Reversal Risks Are Building

Note that gross-shorts against the Japanese yen have reached a record high among large speculators and asset managers on the CME futures exchange. Gross-longs are also perking up among both sets of traders. This hints at a potential sentiment extreme for the yen short trade and brings the potential for mean reversion lower on USD/JPY. But for a sharp reversal lower to happen any time soon on USD/JPY, the Fed need to allow it.

Source: CME, IMM, CFTC (COT, LSEG)

 

 

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-- Written by Matt Simpson

Follow Matt on Twitter @cLeverEdge