Markets are split on whether the Federal Open Market Committee will raise rates at next week’s September meeting, leaving unusually little consensus so close to the decision. Attention is concentrated on a single release: Friday’s US CPI print for August. A higher-than-expected number could strengthen the case for a hike, although the Fed’s reluctance to be led by incoming data means the report may still not settle expectations.
With the inflation data pending, the dollar’s near-term direction may be shaped more by overseas developments, particularly in Japan. A sharp yen rally is being watched because large USD/JPY swings often filter into smaller moves in the dollar against other currencies. A 25 basis point rate rise by the Bank of Japan is now widely anticipated for next week’s meeting, and more hawkish rhetoric could push USD/JPY lower, especially if accompanied by further FX intervention in coming days.
Uncertainty Surrounding the FOMC and US Dollar Volatility
We are facing an unusually split market ahead of next week’s September FOMC meeting, with traders highly undecided on whether the Fed will raise rates. Derivative traders must brace for high volatility because this Friday’s August CPI release is expected to be the deciding factor. Fed fund futures currently show an almost even 50-50 split on the rate decision, which is incredibly rare this close to the meeting.
We suggest that derivative traders look into straddle or strangle options strategies on the US dollar to benefit from the sharp moves expected after the inflation report. A hotter-than-expected CPI print—surpassing the projected 2.5% annualized rate—could quickly embolden the hawkish camp. Still, because the current Fed is notoriously averse to giving clear guidance, we advise against heavy directional bets before the actual meeting.
Japanese Yen Rally and Central Bank Risks
We also need to look beyond the US and watch the sudden, aggressive rally in the Japanese Yen. The Bank of Japan seems locked in to raise rates by 25 basis points next week, which would push their benchmark rate even higher. If Japanese policymakers accompany this hike with hawkish comments or direct market intervention, it could easily send the USD/JPY pair tumbling.
We recommend using short-dated put options on USD/JPY to protect against a sudden break below key psychological support levels like 140. Implied volatility for one-week yen options has already spiked, showing that the cost of protection is rising quickly. Keeping position sizes smaller than usual will help us manage the overlapping risks of these two major central bank meetings.
