Yen Falls as BOJ Updates Policy, Fed Rate Decision Now in Focus

The Japanese Yen fell as the Bank of Japan introduced an updated QQE stimulus effort with new parameters aimed at controlling the yield curve. The currency briefly rose on news that the central bank opted to keep the target interest rate as well as the pace of asset purchases unchanged but the move was swiftly overturned as details on the new regime crossed the wires.

Policymakers pledged to grow the monetary base until inflation is stable above 2 percent, scrapping the maturity target for JGB holdings and promising to keep 10-year rates around current levels. They added that additional stimulus including a possible further cut of the short-term policy rate and/or the long-term target will be considered as needed.

BOJ members voted 7-2 on the updated guidelines for asset purchases and 8-1 on the commitment to overshoot the inflation target. Commenting on economic conditions, officials said deflation has ended but the influence of oil prices, the sales tax and overseas factors will keep price growth subdued for the time being.

All eyes are on the FOMC policy announcement from here. Financial markets price in the probability of a rate hike at 22 percent, suggesting that relatively few investors will be surprised if Federal Reserve officials opt for the status quo this time around. This will shift the spotlight toan updated set of economic and rate-path forecasts as well as a press conference with Fed Chair Janet Yellen.

Comments from most US central bank officials including Yellen and Vice Chair Fischer have struck an increasingly hawkish tone over the past month, telegraphing an intention to resume stimulus withdrawal. At the same time, policymakers have clearly shied away from tightening either against a backdrop of risk aversion or in an environment where their actions may significantly sour sentiment.

This means the Fed’s tone is likely to be cautiously but unmistakably hawkish, pushing markets toward firmer bets on a December hike. This will be meant to reduce surprise risk, smoothing volatility when the increase occurs. Coupling this with a downgrade of the projected rate hike path may help limit fallout this time around and maintain flexibility to adjust perceptions at the November meeting.

The US Dollar is likely to trade broadly higher against its counterparts in this scenario. The yield-sensitive Australian Dollar may suffer outsized losses relative to other major currencies. The New Zealand Dollar might be more reserved however as markets wait for the RBNZ rate decision before taking bets in earnest.

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