All eyes are on the Fed and the Bank of Japan this week and amidst the uncertainty of how the banks will act, volatility could be the big winner. After months of “will they, won’t they” we finally find out this week what the Federal Reserve’s decision on monetary policy is for the final realistic chance of a move in rates prior to the Presidential election. Some in the market have been arguing that there has been a shift to a more hawkish rhetoric from several members of the FOMC (Fischer, Rosengren and even Fed chair Yellen) which could mean a hike on Wednesday. As much as I disagreed with them at the time (there was still too much ambiguity in their language), the stream of economic data disappointments in recent weeks means this will not happen and the market has priced out a rate hike. As much as anything, the Fed does not want to spring a surprise on the market on Wednesday. However, the FOMC press conference could be used to set up for a December hike. In my opinion the Fed runs a serious risk of losing credibility (if it has not already) if it fails to hike in 2016 (a year in which there could have been four hikes). This could further steepen the yield curve and pull near term dollar strength.
There is another crucial central bank announcing on Wednesday (aside from the RBNZ) but the next move of the Bank of Japan comes with considerable uncertainty – which will therefore drive volatility. Although it may opt for caution in front of the FOMC (the Fed announces just hours later), the BoJ could be set to adjust QE to buy shorter dated JGBs, steepen the yield curve and leave it room to cut the deposit rate.