Fed Officials Rein In Market Rate Expectations, USD/JPY Eases from its 24-Year Highs

Fed Keeps its Cool

As we wrote yesterday, Wednesday's shockingly high inflation data from the US, which showed that headline CPI jumped 9.1% in June to the highest level in four decades, puts more pressure on the Fed for another outsized move on rates next week.

Two prominent Fed hawks and voters however, did not break away from the central bank's clearly communicated path for a 50-75 basis point hike, speaking after the CPI release.

In an interview on Nikkei Asia, St Louis Fed President Bullard did not favor a more aggressive full percentage point rate adjustment, saying that he "would advocate a 75 basis points again at the next meeting" and that the bank is "on a good pace, for now". ^[1]

Separately, Governor Waller also supported "another 75-basis point increase" at the upcoming meeting, but noted that if today's retail sales and next week's housing data come in "materially stronger" than expected, then he could "lean towards a larger hike". ^[2]

Markets Expectations Split

The CPI report had sparked an aggressive repricing in markets expectations, with CME's FedWatch Tool projecting a full percentage hike this month yesterday, with around 80% probability. However, yesterday's reserved stance from the aforementioned super-hawks, poured cold water on those bets.

At the time of writing, CME's FedWatch Tool shows a split probability, between a 1% and a 0.75% rate increase, in next week's meeting.

The Fed's communication blackout period kicks-off over the weekend and this makes the delivery of a 100 basis points hike harder in our view, since up until now, officials have not really prepared markets for such an outcome.

Cautious Sentiment

Markets have been fretting over prospects of a global recession due to surging inflation, high energy prices and supply disruptions, as well as the aggressive monetary tightening form many major central banks.

Today markets remain on edge, as economic data from the world's second largest economy, provided a fresh source of worries. The Chinese economy contracted by 2.6% in the second quarter (quarter-over-quarter), although it managed to eke out 0.4% growth on a yearly basis.

June Retail Sales were the bright spot of today's data, since they rose 3.1% year-over-year, while Industrial Output strengthened by 3.9%, albeit less than expected.

USD/JPY Analysis

The US Fed is ahead than most of its major counterparts with front-loaded rate hike cycle and this differential is most pronounced against the Bank of Japan, which has led to massive rally of USD/JPY.

The pair gains close to 2% this week, having hit fresh twenty-four year highs on Thursday, in the aftermath of the shockingly high inflation form the US, which reinforces the Fed's tightening.

This has brought the September 1998 high (142.49) in the spotlight, although bulls will likely need fresh impetus to take it out, while head towards 145.00.

As expectations for a bigger 1% move ease and sentiment remains cautious, USD/JPY faces pressure today and a test of 137.01 would not be surprising. However a deeper correction that would breach the EMA200 (134.60) and could pause the bullish momentum, appears hard at this stage.

From today's economic calendar US Retails Sales stand out, while stock markets in Japan will remain closed on Monday.