The Federal Reserve of the United States (Fed) will announce its monetary policy decision in less than two hours, and the world’s financial markets are on high alert.
Stocks, bonds, and FX rates will witness increased volatility after today’s FOMC Statement and press conference. But out of the three, the FX market is the one to keep a close eye on.
Any clue given by the Fed regarding the terminal funds rate will move the markets significantly. In particular, three currency pairs are worth watching – the EUR/USD, EUR/JPY, and AUD/USD.
Today’s monetary policy decision is about the US dollar. Therefore, all US dollar pairs will fluctuate more than usual, but the EUR/USD should be more volatile.
European economies have suffered from high inflation and the war in Ukraine. As such, shorting the euro has been a popular (and crowded) trade this year.
But regardless of the plenty of reasons to short the euro, the EUR/USD exchange rate still hoovers around parity. One might say that it is consolidating before a big move, and today’s Fed decision might be just the catalyst for such a move.
The biggest trade this year was shorting the JPY. As a result, all JPY pairs advanced in 2022, especially after the USD/JPY broke above 116.
Yet, staying short the JPY at this time of the year is risky because of two things. First, the Bank of Japan intervened (twice) in the FX market by buying the JPY and selling the USD. As such, the USD/JPY corrected from its yearly high above 152.
Second, profit-taking might push the JPY pairs lower in the weeks ahead. The fear of further central bank intervention and the proximity of the end of the trading year are enough to scare many traders out of their JPY short trades, but traders should remember that the Bank of Japan sells USD. Hence, long EUR/JPY may be the right trade for those willing to keep selling the yen.
Last but not least, traders should watch the AUD/USD pair today. Besides the Fed’s decision, the Reserve Bank of Australia (RBA)’s decision comes early next week.
The RBA slowed the pace of tightening, but inflation climbed above its forecast. It may deliver a hawkish statement next week to catch up and if the markets perceive the Fed as dovish today, then the AUD/USD may rally more than other pairs.