With Fed fund futures only pricing in one rate hike in 2019, short USD/JPY?

Dollar has been on a sell-off as investors predict a dovish Fed later tonight. This is also the last FOMC monetary policy meeting in 2018. Even though Fed is widely expected to increase rates by 25bps, markets are fearing that Fed might “release the doves” due to a few reasons:

• Fed President Powell’s speech previously mentioned that rates are “just below” the neutral rates which could mean that Fed is likely to slow down the pace of the tightening cycle.
• There are signs of slowing in the US manufacturing, agriculture and housing sectors.
• Intensifying trade tensions between the US and China which were aggravated by the arrest of Huawei’s CFO.

All eyes will be on the dot plot projections tonight to see if there are any changes to the number of rate hikes in 2019. The Fed currently sees three rate hikes in 2019 and any changes in the forecast could shake the market. On the other hand, the Fed fund futures are only pricing in one rate hike in 2019.

As most investors are already betting on a dovish Fed, a statement that makes clear that further rate hikes are needed and the forecast of three rate hikes in 2019 remains, will cause the dollar to surge. However, if Fed reduces the forecast from three hikes to two, the extent of the dollar’s fall will depend on the Fed’s tone.

We believe that Fed still wants to raise interest rates in 2019, but given the prevailing economic and political conditions, they could reduce the aggressiveness. Furthermore, there is no reason for Fed to be hawkish tonight because stocks and yields are falling while the dollar is weakening. Lower yields and a weaker dollar could help to lessen the pain of falling stocks.

USD/JPY could fall towards 111.00 before finding any support and once the support is broken, USD/JPY will be heading for a long-term down trend.