Rate cut and QT end by the Fed & hold from BoJ despite Bessent post

USD: Fed likely to deliver what’s expected

The FOMC meeting takes place tonight and the US dollar remains in its recent range with limited signs of appetite for this range to break over the short-term. With tonight unlikely to result in any great surprises from the FOMC we don’t see this range for the dollar breaking, perhaps until we get to see some key data points – in particular the monthly jobs reports that will be key in shaping changes to current market expectations. Since the beginning of June, the DXY index has traded in a 96-100 trading range for the entire period, bar two trading days when it traded above the 100-level. Over roughly the same period though, the 10-year UST bond yield has declined by nearly 50bps with the 2-year yield down by around the same amount. Yields in Germany have increased over the same period – the limited impact on the dollar of course reflects the record drop recorded in H1 this year.

We would expect the rate cut tonight to be accompanied by a statement that again is balanced in relation to future moves. The statement in September when the FOMC cut by 25bps did not indicate a bias in future possible moves and given the lack of jobs data since the last meeting there is now even less incentive at this stage to provide any formal guidance in the statement. The additional uncertainty with a possible US-China trade deal being announced on Thursday adds to the reason for caution on guidance. The press conference in September made it clear that it was the labour market that provided the greatest justice for cutting rates which of course won’t be the case tonight given the lack of NFP data. The CPI data last week did still show goods inflation picking up so tariff-related inflation is coming through, but Powell will probably conclude again the impact is smaller than had been anticipated.

Fed Chair Powell in a speech since the last FOMC meeting also gave a clear hint that the Fed was close to ending QT and we suspect this will be confirmed at the meeting tonight. The SOFR/fed funds spread has drifted a little higher this month and Fed repo operations indicate there has been some increased demand for cash. There seems little reason to delay given the signal provided by Powell earlier this month.

For short-term rates and FX post-decision reaction will likely come down to Powell’s interpretation of the inflation risks. Will the Fed view last week’s data as good news – services disinflation is offsetting the pick-up in goods inflation due to rents. Or will the Fed look at the goods inflation in isolation and worry about tariff-related inflation risks ahead and therefore express some increased caution on the path ahead in taking the fed funds rate back to neutral? Given the lack of jobs data we certainly expect Powell to attempt to remain balanced and would not want to shift market expectations at this juncture only for updated jobs data to contradict that shift. That would mean the current market pricing being effectively endorsed which should reinforce the potential for some renewed dollar weakness if the US-China outcome helps to encourage renewed non-dollar buying on reduce global growth fears.

SOFR/FED FUND SPREAD WIDENING TO ENCOURAGE FED QT TERMINATION

Source: Bloomberg, Macrobond & MUFG GMR

JPY: BoJ to hold but a hike is coming with help from the US

Within 12 hours of the FOMC decision tonight the BoJ will announce its policy decision and given a new government led by PM Takaichi is only just in place, the BoJ is widely expected to keep the policy rate unchanged at 0.50%. The yen initially jumped in early trading in Asia in response to a post by US Treasury Secretary Scott Bessent who appeared to be attempting to reinforce the statement put out yesterday by the US Treasury following his meeting with Finance Minister Katayama that suggested BoJ monetary policy was a key factor in the undervalued level of the yen. Katayama yesterday denied that was how the statement should be interpreted and it appears this post on X by Bessent was an attempt to undermine that denial. The fact that in the post on X Bessent emphasised the need to allow the BoJ “ policy space” was key we believe can be seen as a further attempt to portray the US view that the BoJ needs to address yen weakness via monetary tightening. He added that he was “encouraged” by Katayama’s understanding that ‘Abenomics’ was no longer about reflation and that inflation was an issue that needed to be addressed in policy steps. We will ignore here the huge irony of the Trump administration calling on another country to give its central bank “policy space”! But this more explicit comment from Bessent will certainly act to discourage yen selling at these levels.

The primary focus in tomorrow’s decision, assuming policy remains unchanged, is whether there were any additional dissents. The last meeting say two policy members voted for an immediate hike (Tamura and Takata) and if another member was to join in the dissent it would fuel stronger expectations of a hike, in December. Junko Koeda is seen as one of the most likely candidates to possibly join the dissenters. December is currently priced at close to a 50% probability while by January it is a 90% probability. Updated forecasts will be released and we see limited changes with core-core annual CPI at 2.8% this fiscal year; 1.9% in FY26 and 2.0% in FY27. Growth could be a touch stronger for the current fiscal year. We’d expect Governor Ueda to play down any political influence in specific BoJ decision-making but in the context of the Bessent comments his views in the press conference on the impact of the yen on inflation will be important. Overall we would expect the BoJ to repeat its key guidance that a rate hike will be required if the economy continues to evolve as expected. We believe the BoJ should guide the markets toward a December hike especially given the primary factor in delaying until now – trade policy uncertainty – looks to be receding further and in any case equity markets in many parts of the world are at record highs. In that scenario and following the rate cut from the Fed tonight, downside scope in USD/JPY is certainly set to build.

BOJ POLICY RATE IN REAL TERMS REMAINS WELL BELOW THE ESTIMATED RANGE FOR R* - THE BOJ IS IN DANGER OF BEING BEHIND THE CURVE

Source: Macrobond, Bloomberg & MUFG Research

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com