USD/JPY could rally after the Fed, but needs more than “just” a rate hike

<p>Markets are understandably on edge ahead of this afternoon’s historic Federal Reserve meeting, where the Fed is pondering its first interest rate hike in nearly […]</p>

Markets are understandably on edge ahead of this afternoon’s historic Federal Reserve meeting, where the Fed is pondering its first interest rate hike in nearly decade. As we noted in our full FOMC preview, there will be plenty of new information for traders to digest between 2:00pm and about 3:30pm ET, when Janet Yellen’s press conference winds down, but regardless of what the US central bank opts to do and say, volatility is likely.

Traditionally, the currency pair that tends to have the cleanest and most logical reaction to major US economic developments is USD/JPY, and we expect a similar dynamic today. If the Fed comes off as more hawkish than expected, perhaps by implying another interest rate hike is possible in Q1 2016, USD/JPY should strength back up toward November’s trading range around 123.00. Conversely, if the Fed delivers the so-called “dovish hike” scenario, USD/JPY could drop back toward 120.00 (118.50 could even be in play in the longshot scenario where the Fed leaves interest rates unchanged).

Technical view: USD/JPY

Turning our attention to technical developments presents a mixed picture for USD/JPY. The pair did drop out of November’s sideways range near the 123.00 level, prompting the lagging MACD indicator to turn negative in a signal that the momentum now favors the bears.

That said, the improvement over the first 48 hours of this week’s trading still points to more upside in our view. On Monday, USD/JPY found support at the rising trend line off August’s 11-month low, and Tuesday’s bullish candle created a clear Morning Star pattern on the daily chart. For the uninitiated, this relatively rare 3-candle reversal pattern shows a shift from selling to buying pressure and often marks significant bottoms in the market. Finally, the more timely RSI indicator has turned higher off its corresponding support level around 40, signaling that the bullish trend remains healthy despite last week’s counter-trend dip.

Of course, the on-balance bullish technical evidence may be all for naught if Yellen and company don’t offer any hawkish nuggets to USD/JPY bulls. Therefore, traders may want to wait for the interest rate decision, statement and summary of economic projections at minimum before committing in either direction, with more conservative traders tuning into to see whether Dr. Yellen’s press conference confirms the initial reaction as well.

After all, the Fed’s waited nearly a decade to start raising interest rates, so waiting a few extra hours to fully evaluate the long-term implications of the potentially historic shift back toward tightening may be prudent.

* A Morning Star candle formation is relatively rare candlestick formation created by a long bearish candle, followed a small-bodied candle near the low of the first candle, and completed by a long-bodied bullish candle. It represents a transition from selling to buying pressure and foreshadows more strength to come.

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