The sell-everything trade has mostly paused for breath over the last 24 hours, with US equities finding their feet overnight, Asian equities rallying today, and the US dollar giving back some of its recent gains. Bond markets remain the exception. The Bank of Japan is buying JGBs furiously to maintain the yield cap, while US bond yields continued to rise leaving the yield curve almost flat and dangerously close to inversion.

Markets brace for 0.75% hike from Fed

Given bond markets saw no love overnight, I am inclined to believe that clawing back losses elsewhere is merely a consolidation ahead of tonight’s FOMC policy decision. The market has priced in at almost 100% an FOMC hike of 75bps this evening. My two cents worth is that the Fed will not go 100bps, as that would further erode their credibility on the forward guidance front, which is already ragged. They may, however, decide to upgrade their forward guidance to an even more hawkish tilt. I suspect 75bps is already built into prices now, and if the guidance is more modest in scope, I am sure the buy-the-dippers will be out in force for the rest of the week.

I remain concerned that the Bank of Japan policy meeting is an underrated risk point this week, perhaps even more so than the FOMC outcome itself. A 100bps hike tonight, and/or a very hawkish outlook, will lift USD/JPY once again and may force the BOJ into lifting the 10-year JGB yield cap slightly, despite their actions in the bond market this week. That could, in turn, prompt a very ugly, somewhat short-term correction lower by USD/JPY that could reach 130.00. Expect GBP/JPY, AUD/JPY, and NZD/JPY to get a pasting as well.

The Bank of England rate decision tomorrow will become murkier as well if the FOMC is uber-hawkish tonight. The BOE most likely intends to hike by 0.25%, but with sterling under some serious pressure right now, its hand may be forced even though it has admitted it has only limited means to manage imported inflation from here. One positive note is that unemployment remains very low in the UK, giving the BOE a decent starting point to inflict monetary pain.

https://www.fxmag.com/economics/noisy-pre-fomc-consolidation