The Week Ahead: FOMC, BoJ, German Elections

Amid unexpected global risk events as the trading week wound down on Friday, including another North Korean missile launch over Japan a day earlier and a train explosion in London that has been attributed to terrorism, international markets were mixed while US equities once again shrugged off concerns and continued to grind higher in record territory. The British pound surged sharply higher on the back of this week’s hawkish Bank of England decision that hinted at likely policy tightening on the horizon. The US dollar weakened against other major currencies after significantly worse-than-expected US retail sales data on Friday pressured the greenback. A notable exception to this dollar-weakening was USD/JPY, which initially dropped on safe-haven demand for the yen but then rose sharply as markets generally shrugged off geopolitical worries and the yen proceeded to sell-off, partly on concerns about Japan’s vulnerability to North Korean missiles. The sustained low level of risk aversion in the markets also continued to place pressure on the price of gold, which was additionally weighed down by this week’s higher-than-expected US consumer inflation data that suggested a potentially higher probability of a Fed rate hike this year.

FOMC policy stance after inflation rise

The markets should find out more about this probability in the week ahead, which features the Fed’s eagerly awaited September policy decision on Wednesday. Currently, the market’s view of the likelihood that the Fed will raise interest rates next week is still very close to zero. The market-viewed probability of a rate hike by the end of the year, however, has risen significantly above 50% in the wake of this week’s noted US consumer inflation release. As usual, the Fed’s tone and stance during next week’s FOMC statement and press conference will play a major role in setting expectations for interest rates, the Fed’s balance sheet reduction plans, and the US dollar going forward. Despite the higher-than-expected CPI inflation reading, the question remains as to whether it will be enough to produce a hawkish shift in the Fed.

BoJ likely to remain dovish

Another potentially impactful event for the currency markets next week will be the Bank of Japan policy decision on Thursday. Again, no changes in monetary policy or interest rates are expected. However, any changes in the central bank’s forecasts, most notably for inflation, could have ramifications for the yen. More than likely, the BoJ will reinforce its position as one of the very few major central banks to remain staunchly dovish amid a growing global trend of hawkish-leaning monetary policy.

German elections and the euro

In Europe, a flurry of manufacturing and services PMI releases from France, Germany, and the Eurozone as a whole will be released on Friday. Potentially more pivotal for markets, however, will be Germany’s federal election slated to be held on Sunday, September 24th. This event will elect members of a new government which will, in turn, elect the German Chancellor. The current Chancellor, Angela Merkel, and her party, the Christian Democratic Union (CDU), have maintained a comfortable two-digit lead over their closest rival, the Social Democratic Party (SPD) led by Martin Schulz, in ongoing polling. Central to this election is the longstanding migrant crisis in the country. Right-wing nationalist party, Alternative for Germany (AfD), is both anti-immigration and anti-EU. While this group is only represented on a regional level, it conceivably has a chance to secure a significant portion of votes. From a currency perspective, the AfD’s election performance and potential to be represented in the Bundestag will be of primary concern with respect to the euro. Much like the French election earlier this year, the fear of any power in the hands of anti-EU nationalists represents a significant threat to the viability of the shared currency, particularly since Germany is a dominant member of both the European Union and Eurozone. In the event that a victorious Merkel continues to lead a new coalition government and the AfD ceases to pose a present threat, the euro could potentially rally further than it already has in the past five months.

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