(Bloomberg) -- Traders are entering the week with a keen focus on the Federal Reserve meeting on Wednesday, where the US central bank is expected to leave its policy rate unchanged. That risks underestimating the potential of the Bank of Japan’s meeting earlier the same day to roil global markets.
- The yen’s stunning rally last week, and the fallout that had for carry trades and global equities alike, makes the BOJ a potential wild card this week. The expected outcome of the two central bank meetings should be positive for the yen.
- That should concern investors expecting a softer Fed to bring back the mojo for equity markets, given the way that the yen’s rally last week spurred steep declines for risk assets.
- The BOJ is forecast to commence quantitative tightening, with rates and FX traders anticipating a strong chance of a rate hike. Meanwhile, markets are fully pricing in a Fed rate cut in September, leading to the expectation that Fed Chair Jerome Powell will signal the possibility of easing.
- Tokyo policymakers are more likely to surprise than those in Washington. BOJ Governor Kazuo Ueda’s year and a bit in office has been marked by disappointments for those expecting decisive action, despite core inflation holding at or above the central bank’s target since April 2022. This lowers the bar for a hawkish surprise — even a hold could deliver one if the path laid out for trimming bond purchases and raising rates is bold enough.
- The yen appears poised to surge again if the BOJ-Fed combination favors the currency. Bears remain vulnerable even after a rapid reduction in yen shorts from historically extreme levels. A combined gauge of positioning for the currency — using z-scores for both CFTC data on speculators and Citigroup’s pain indexes tracking active FX traders — hit bearish levels only seen five times before. Each instance led to a reversal that overshot to the bull side, except for March 2021 when anticipation of an approaching Fed hiking cycle revived bearish bets.
- The uncertainty pervading global markets amid marked geopolitical turmoil also threatens to feed into the mix. Witness the tendency over the past couple of weeks for the yen to revisit a haven role many had thought long lost.
- That makes risk assets already vulnerable to concerns that the Fed’s move toward easing signals a severe slowdown may occur for the US — a “landing” is coming for the economy and it could yet be hard instead of soft.
- A fresh burst of yen strength looms as a strong risk, and one that could set off fresh liquidation trades. This month saw the correlation between USD/JPY and the S&P 500 Index turn positive for the first time since 2Q 2023, back when global banking wobbles spurred recession concerns.
- Investors may want to hope that Ueda springs another dovish disappointment, or that US megatech earnings and labor data are benign enough to counteract any repeat of last week’s yen-enhanced pain trades.
- NOTE: Garfield Reynolds leads Bloomberg’s Markets Live blog in Asia. The observations he makes are his own and are not intended as investment advice. For more markets commentary, see the MLIV blog.
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