Pre-FOMC USD Price Action Setups

USD Talking Points:

• Kevin Warsh has a tough task ahead: Markets are expecting a hike and it seems likely that the bank will vote that way, but in the accompanying press conference Warsh can make his mark. If he sounds overly hawkish, stocks could pullback as the Nasdaq has started to lag behind the S&P. But if he sounds closer to dovish, Treasury yields could continue to flare thereby setting a problem for Scott Bessent.
• The BoJ rate decision is also important and despite a 25 bp hike being expected there, Kazuo Ueda will probably need to pledge to more hikes if he doesn’t want USD/JPY to rally significantly beyond the 155.00 level.

The deck is loaded for this week and FOMC and BoJ rate decisions can impact much more than just the FX market. At current, both US and Japanese 10-year yields have set fresh multi-decade highs and for two countries with massive debt loads that will need to continue to tap debt markets, that’s a significant risk.

If market participants think the representative central bank isn’t serious about fighting inflation, there’s even less reason to hold those bonds. And less motive to buy or hold long bonds means more supply, lower prices, and higher yields.

On the other side, central banks going overly hawkish run the risk of equity market sell-offs and we’ve already seen Japanese stocks soften significantly on just the prospect of a shift at the BoJ. So each central banker is in a very sensitive spot where they really need to thread the needle.

In the FX market, it really still seems that the USD/JPY carry trade dominates and one look at the weekly chart explains why. The pair is still up more than 50% from the early-2021 value and that level of Yen weakness helps to explain why the USD hasn’t dropped more given the 175 bps of cuts over the past two years.

This also highlights a still-crowded carry trade, and 25 bps of hikes from Japan won’t solve that issue, so Ueda really needs to do something else to get longs shocked into closing positions.

USD/JPY Weekly Chart

Chart prepared by James Stanley; data derived from Tradingview

USD

As note of how impactful USD/JPY is to the DXY basket at the moment, last week was really very bullish for USD as surging Treasury yields and rate hike odds to go along with strong data was not enough to produce a green weekly bar. Instead, price held prior support and so far into this week the DXY basket has bounced as USD/JPY has pushed in that 155.00 test.

So while Warsh’s appearance tomorrow is vitally important, I still think USD is dominated by USD/JPY themes. So if Warsh is overly-hawkish, we could see a bullish breakout which would then put the ball in Ueda’s court for Thursday/Friday when the BoJ announces.

Right now, for DXY, it’s the 100-100.22 level that looms large as resistance. A hold there sets up for a possible lower-high but, again, that will probably need some help from a hawkish BoJ.

US Dollar Weekly Chart

Chart prepared by James Stanley; data derived from Tradingview

--- written by James Stanley, Senior Market Analyst, Global Macro