USD/JPY Forecast: FOMC Meeting – A Hawkish Hold or Surprise Rate Hike?

When is the FOMC rate decision?

The July FOMC rate decision will be announced on July 29 at 18:00 GMT (14:00 ET), followed by Fed Chair Kevin Warsh's press conference at 18:30 GMT (14:30 ET).

What are the expectations for the Fed rate decision?

The Federal Reserve is widely expected to leave interest rates unchanged at 3.5% to 3.75%.

However, market expectations remain among the most divided in recent history. According to the CME FedWatch Tool, Fed funds futures are pricing in around a 30% probability of a 25-basis-point rate hike this week, up from 12% just two weeks ago.

Looking ahead to September, the market is pricing in an 80% probability of a 25-basis-point hike. Given these hawkish expectations, if the committee and Fed Chair Kevin Warsh fail to signal that another hike remains on the table, markets could react sharply.

Adding to the uncertainty, Warsh has all but eliminated forward guidance, leaving investors with little direction ahead of the announcement. Given the significantly shorter Fed statement under the new Chair, the number of dissents will be closely watched in the absence of more explicit guidance.

The cooler June CPI report and steady payroll growth provide reasons for the Fed to argue against immediate action. However, with oil prices now well above June levels and uncertainty surrounding the inflation outlook, the policy debate could centre on whether progress on inflation justifies continued patience or whether inflation remains high enough to warrant another rate hike later this year.

How could the FOMC impact the market?

The base case is for the FOMC to leave interest rates unchanged in a 10-2 vote, while keeping the door open to a September hike—in other words, a hawkish hold. More than two dissents, together with stronger language around inflation risks, could push Treasury yields and the U.S. dollar higher at the expense of stocks and gold.

On the other hand, a single dissent or a unanimous decision, together with a greater emphasis on temporary inflation pressures and confidence that inflation has peaked, could drag on yields and the USD as the market lowers rate hike expectations.

Volatility could be higher than usual given the new Chair's emphasis on reduced communication. Post-meeting data may become even more important if the Fed statement offers few clues and Warsh keeps his press conference brief. June PCE inflation and Q2 GDP will both test the disinflation narrative and could play a key role in shaping expectations for potential rate hikes in September and December.

A word on the BoJ

It's also worth noting that the BoJ is due to announce its rate decision on Friday and is expected to leave rates unchanged at 1%.

While recent developments bolster the case for further rate hikes and expectations of additional tightening, the yen has continued to struggle. Investors remain unconvinced that the BoJ can turn significantly more hawkish, given political sensitivities.

USD/JPY technical analysis 

USD/JPY is consolidating below a four-decade high near 164. The price trades above its rising trend line and its major EMAs, keeping the outlook constructive. 

A hawkish Fed and assuming the Japanese authorities don't intervene at 164, the next key level of resistance is seen at 165, the round number. 

On the downside, support can be seen around 162.50, the mid-July high. A break below here exposes the 50 EMA at 161.50 before turning attention to the 160 support zone.