Forex Outlook: markets will eventually have to price in potential interest rate rises
iNVEZZ, Wednesday, May 21: the focus today is on central banks; more on their talk rather than action.
Overnight there was little surprise to see that the Bank of Japan stuck to their current policy path after the latest meeting, but there is a growing consensus that they will be prompted to do more by mid-year as the inflation dynamics start working against them (pushing downwards on annual inflation). USDJPY was initially lower on the news and is currently fighting with the 101.20/23 area of which we spoke at the start of the week. The Nikkei is also close to the key 14,000 level, which has offered key support for most of the year to date. A break lower here and below 101.20 on USDJPY could well set us up for further yen strength, which naturally would not be a welcome development for the authorities.
For today, note that minutes from both the Bank of England and Federal Reserve will be a focus for markets. In the UK, the debate is multi-faceted, given that there is a strong focus on the housing. Both the chancellor and prime minister were talking about this yesterday and making clear the Bank has the tools to act, via the financial policy committee who have the power to enact certain measures and offer clearer guidance than was the case for the Bank in the pre-crisis era. It may be too early to expect the MPC minutes today to start offering signs of broader dissent, but we are probably not that far off a time when we are likely to see more pronounced splits in thinking. What is troubling central bankers is that volatility in many asset markets (FX included) is at multi-year lows and the feeling is that markets are too complacent regarding the potential risks ahead. But central banks have been a part of this, in offering explicit forward guidance so as not to spook markets into fearing a set back from the low interest rate environment. At some point, markets will have to start pricing in this wall of worry and it may not be such a bad thing.
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