The Federal Reserve delivered a widely anticipated 25 basis point rate cut yesterday but surprised markets with a notably hawkish tone. While the rate cut was in line with expectations, the updated dot plot projections indicated only 50 basis points of further easing in 2025, signalling a cautious policy outlook. One Federal Open Market Committee (FOMC) member even voted to hold rates steady, underscoring the restrained approach.
Fed Chair Jerome Powell emphasised that further rate cuts would require more substantial progress on inflation. This shift contrasts with the more dovish posture the Fed adopted earlier this year, which was driven by concerns over the labour market. Powell’s latest remarks indicate that those risks have diminished, eliminating the urgency for additional easing.
Dollar Strengthens on Fed Communication
The Fed’s hawkish stance sent the dollar surging to new highs. The US Dollar Index (DXY) is now trading at 108.0, building on its robust momentum. Market expectations for rate movements remain firmly anchored, with no changes anticipated in January and a modest 11 basis points priced in for March.
This recalibration of the Fed’s messaging has set a high bar for economic data surprises to impact the dollar’s rate advantage, paving the way for sustained dollar strength into 2024.
Bank of Japan Takes a Dovish Turn
In contrast to the Fed, the Bank of Japan (BoJ) opted for a cautious hold, which markets interpreted as a dovish surprise. Although consensus had anticipated no immediate action, there was an expectation that the BoJ would signal more openness to a potential rate hike in January.
Governor Kazuo Ueda emphasised a data-driven approach, stating that more information on wages and growth is required before making any decisions. This hesitancy has weighed on the yen, further fuelling the strength of the dollar against the Japanese currency.
USD/JPY Eyes the 160 Level
The divergence between the hawkish Fed and the cautious BoJ has propelled the USD/JPY pair past the 155 level. Analysts now predict the pair will move toward the 158–160 range. This marks a critical area where the BoJ has previously intervened, selling nearly $100 billion to stabilise the yen earlier this year.
While the BoJ might step in again to support its currency, historical precedence suggests the US Treasury is unlikely to oppose such efforts, especially given Japan’s broader economic challenges.
Looking Ahead
The contrasting monetary policy approaches between the Fed and the BoJ highlight a widening gap in interest rate expectations, favouring the dollar in the near term. With the Fed maintaining its hawkish stance and the BoJ signalling caution, USD/JPY’s trajectory towards 160 seems increasingly likely.
Investors will now turn their focus to upcoming economic data and central bank communications for further insights into currency trends and potential interventions.
