Market trades cautiously ahead of Fed and BOJ meeting

Volatilities declined for the fourth day as markets trade cautiously ahead of the interest rate and monetary policy decisions made by the Federal and BOJ today.

Everybody is holding their breaths – awaiting the BOJ’s monetary policy statement at noon and the Federal’s interest rate decision at 2am tomorrow morning. Asian markets were mixed on Tuesday with narrow trading ranges. US markets erased earlier gains and closed marginally higher, as a worse-than-expected US Housing Starts number has disappointed the market.

Are the markets underestimating the Fed’s intent to hike interest rates?

Views were divided between the Fed’s preferred bond-trading partners. Two out of the 23 primary dealers, namely Barclays and BNP Paribas, are betting against the consensus by forecasting a rate hike tonight. They stated that market steeply discounted the officials’ intent to hike interest rates.

In light of a worse-than-expected US job data in August, market has priced-in a low chance (about 20% probability) of a September rate hike. However, any surprise moves or hawkish comments on the next rate hike could potentially dampen the enthusiastic of the recent rally, and pull down indices further. Equities are especially vulnerable to any rate hikes because of their high valuation which will leave them susceptible to change in discount rates.

If that happens, we would expect the dollar to pick up pace quickly, which will weigh further on commodities prices. Equities and bonds will have to be re-evaluated due to rising discounting rates. On the other hand, rising uncertainties will open the window of opportunity for financial safe havens, including gold, silver, treasuries and yen.

US dollar strengthened against its major peers last night, with the Dollar index December future advancing 0.20%to 95.95. GPB/USD dipped below a key support level at 1.3000 and is currently traded at 1.2980 area. USD/JPY changed little, as traders tend to take less risky approach before BOJ’s announcement.

US SPX 500 - Cash

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