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"Heading into next week's FOMC meeting, markets are pricing just a 20% chance of a rate hike. We think the likelihood of a hike are considerably higher and continue to forecast the Fed delivering 25bp of tightening. Our economists expect the Fed will cushion its delivery with reassurances about gradual tightening going forward, a lower projected terminal Fed funds rate and a shift to the dot plot to signal that further tightening this year is not expected.
However, with rates markets underpriced for tightening heading into the meeting and the market short USD, we expect to see a significant, broad strengthening of the USD in response.
If the Fed does elect to leave policy unchanged, we expect the accompanying message to attempt to keep a December hike in play, but markets are likely to be sceptical, and in this scenario the USD would likely challenge the lower ends of its recent ranges vs the EUR and JPY.
In contrast to the Fed, we expect the Bank of Japan to disappoint expectations for easing this week. Our economists expect no action on the Bank's deposit rate and no significant changes to its QE program at this meeting. Surveys show about half of economists expect a move this week, but we note that our position metrics still show significant long yen positioning, suggesting that either market participants do not expect a move or they are sceptical that new action from the BoJ can weaken the yen.
We do not expect a steady policy call this week to result in sharp yen gains, particularly about 12 hours ahead of the FOMC meeting. However, if the Fed does disappoint our forecast, the combination of a steady Fed and steady BoJ policy would likely see USDJPY test back below 100".
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