Week Ahead: FOMC & BoJ Rate Decisions

Last week, the ECB raised interest rates by 25 basis points taking the deposit rate to 2.5%, in line with expectations. ECB President Christine Lagarde didn't give too much away. However, staff projections upwardly revised the inflation and growth forecasts, bringing a more hawkish bias to the decision.

However, EUR/USD failed to benefit after U.S. PPI inflation came in stronger than expected on the same day. U.S. core CPI inflation on Friday also came in higher than expected at 0.3% MoM versus 0.2% expected. As a result, the market lifted Fed rate hike expectations from 70% prior to the data on Friday to 90% after.

Oil prices rose above $100 a barrel as hostilities in the Middle East ramped up, and oil prices are rising again at the start of the new week after further attacks over the weekend.

With inflation rising across the globe, the market is pretty certain that two of the world's most important central banks will hike interest rates this week.

Federal Reserve rate decision

The FOMC rate decision is on Wednesday and comes as inflation has been running above the central bank's 2% target for almost five years. Now, with the war in Iran pushing up energy prices, inflation is proving even stickier. The Fed's preferred measure of inflation, the PCE price index, rose 3.7%, while the core measure rose to 3.3% in July. CPI data on Friday showed that inflation rose to 3.4% in August, as expected, but remains too hot.

At the same time, the market is getting anxious and fretting that the Fed isn't doing enough to rein in inflation. Failing to hike rates would raise these concerns further and also create credibility issues.

Our other big question will be over how Kevin Warsh communicates, whether this will be a one-and-done or part of a longer tightening cycle, particularly given his dislike for forward guidance. Any hints on the outlook for interest rates over the coming months could drive the market reaction.

Investors will closely watch the reaction in U.S. Treasury yields after they recently surged to multi-year highs, driven by inflation worries amid elevated oil prices.

A hawkish-sounding Federal Reserve could lift yields and pull gold lower. However, should the Fed convince the market that it is getting inflation under control, this could, in fact, pull yields lower and help gold and stocks.

Meanwhile, a hike accompanied by guidance that falls short of market expectations could, in fact, leave the USD.

BoJ rate decision

Japan's rate decision comes on Friday, with the Bank of Japan widely expected to raise its policy rate after hawkish comments from officials and strong economic data have boosted the case for tightening. The move is 98% priced in, so attention will be on the BoJ's forward guidance.

Governor Ueda is expected to refer at the press conference to both the risk that underlying inflation could overshoot 2% and the effects of hikes on the economy. The market's focus will be on whether the BoJ signals a faster pace of tightening or maintains a cautious approach to subsequent increases.

Ueda doesn't necessarily need to deliver an aggressively hawkish message to support the yen. However, if the market has already priced in a faster pace of rate hikes, a cautious message could disappoint and trigger some profit-taking.

Ahead of the rate decision will be the August inflation data, where core CPI is expected to rise 1.8%, in line with July.

USD/JPY technical analysis

USD/JPY trades 3.5% lower in September. The price broke aggressively through the 200 EMA and tested key support levels around 157, 156 and 155 before finding support around 153.50 towards the end of the week.

Sellers supported by momentum will look to break below the 152 level, with a sustained move below here strengthening the bearish structure and opening the door towards the 150 psychological level and 148.

Buyers will be watching for a potential rebound above 155, particularly if the Fed is more hawkish and the BoJ offers limited guidance on further tightening.