Fed and BoJ enter the limelight

Will the Fed deliver a hawkish cut?

The US dollar held strong against most of its major peers on Tuesday, extending its gains on Wednesday.

Today, the spotlight for dollar traders is likely to fall on the Fed decision, where the Committee is largely anticipated to cut interest rates by another 25bps. However, coming on top of the stickiness in recent inflation data, yesterday’s better-than-expected retail sales increased the probability of a January pause to 82%.

With that in mind, a quarter-point cut itself is unlikely to shake markets much. Investors may focus more on hints and clues on how likely a January pause is, as well as on how many rate cuts policymakers are contemplating throughout 2025.

The September ‘dot plot’ showed that the Fed was planning to deliver four 25bps reductions next year. But the election of Donald Trump as US President raised concerns that his tariff and tax cut policies will add extra fuel to inflation.

Taking today’s reduction out of the equation, Fed fund futures are pointing to another 50bps worth of reductions by next December. Thus, combined with an already strong chance for a pause at the first gathering of the year, this poses some downside risks for the US dollar.

Even if Fed Chair Powell corroborates the notion of a January pause, a median dot for 2025 pointing to more than 50bps worth of rate cuts could disappoint market expectations and thereby weigh on the greenback. At the same time, bets of lower-than-currently expected borrowing costs may be celebrated on Wall Street, with equity indices continuing to explore uncharted territories.

Will the BoJ signal hikes at the turn of the year?

Before the Fed dust settles, traders may start preparing for another key central bank decision as during the Asian session tomorrow, the central bank torch will be passed to the BoJ.

Investors have significantly reduced bets of a rate hike at this gathering following several media reports suggesting that the Bank should take a more cautious approach, although board members remain willing to continue raising rates due to an expanding economy, rising wages, and above-target inflation.

Now investors are penciling in a 60% chance of a quarter point hike in January, with such an action being almost fully priced in for March. Thus, even if officials decide to stand pat tomorrow, strong hints that a rate increase at the turn of the year is still warranted could prove beneficial for the Japanese yen.

Pound awaits BoE, loonie falls to nearly a five-year low

Elsewhere, the pound continued holding relatively well against its US counterpart, with today’s UK CPI numbers for November confirming expectations of accelerating inflation and corroborating the notion that the BoE will stand pat at tomorrow’s gathering.

According to the UK Overnight Index Swaps, market participants expect British policymakers to refrain from pressing the rate-cut button until March, while they are penciling in only 58bps worth of reductions in December.  Ergo, should the BoE maintain a hawkish stance, the pound is likely to remain supported. It could even finish the year higher against the US dollar if the Fed tonight disappoints current market expectations by delivering a dovish rate outlook.

The loonie tumbled to nearly a five-year low against the greenback, feeling the heat of political uncertainty after the abrupt resignation of Canada’s finance minister, and after data showed a surprise easing in inflation, which increased speculation that the Bank will proceed with another reduction in January.