Limbo ahead of Fed FOMC meeting

A mixed session overnight leaves markets with little direction ahead of the Bank of Japan and Federal Reserve FOMC meetings today. There was no stimulus for markets from the meeting of European officials yesterday while Greece’s debt swap has failed to boost confidence.

Overall there is a real hesitancy for investors to take positions, with both volumes and volatility remaining very low. For instance the VIX volatility gauge has dropped to its lowest level since May 2011 while my measure of composite FX volatility continues to languish at relatively low levels compared to last year.

The USD has little to fear from the Fed FOMC meeting tonight. If anything it may even benefit from a less downbeat statement from Fed Chairman Bernanke following the meeting. Growing speculation that the Fed will embark on some form of sterilised quantitative easing, i.e. not printing any more money, bodes well for the USD too.

Ahead of the FOMC decision a firm February retail sales report will help add to the plethora of evidence revealing stronger signs of US recovery. A key indicator to watch in this respect is the (National Federation of Independent Business (NFIB) report of small business confidence which should also strengthen. Importantly for the USD the data should also help to maintain pressure on US bonds, keeping yields elevated and in turn the USD supported.

The BoJ meeting today will not deliver any surprises, an outcome that will likely leave the JPY largely unmoved. Speculative sentiment for the JPY has shifted negatively as reflected in the latest CFTC IMM report which reveals the biggest short position in the currency since April last year.

Crucial in pushing the JPY weaker has been the widening in bond yield differentials with the US, thanks largely to a rise in US bond yields. The 2-year yield gap is now around 20 basis points, the highest gap since August 2011. This will help to keep USD/JPY supported but my quantitative models suggest that the upmove may be overdone in the short term, with a correction lower in prospect to technical support around 81.44.

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