Currencies' turmoil respite may be brief as US Fed, BoJ set to meet

For currency traders who've been battered by increased volatility, next week may turn out to be the moment of truth.

The yen, a traditional haven, retreated from the biggest two-week rally since mid-2013 on speculation the Bank of Japan (BoJ) will increase stimulus on January 28-29 to revive inflation. The dollar strengthened for a fourth week before the US Federal Reserve meets January 26-27 to consider follow-on policy after raising interest rates last month for the first time in almost a decade.

The $5.3-trillion-a-day currency market started 2016 in risk-off mode on concern that a cooling Chinese economy will send global demand and inflation rates tumbling. Even after a late-week rebound in crude oil prices and global equities, the yen has been the best-performing currency this month.

"Will central banks come to the rescue, or is what's going on in China going to dominate? We think it's going to be the latter," said Calvin Tse, the co-head of the US currency strategy for Morgan Stanley in New York. "Central banks coming in to ease may release a wave of euphoria into the market that we don't think is lasting. We're still bullish on the yen."

The yen fell 1.5 per cent this week, to 118.8 to a dollar in New York, after touching a one-year high. Japan's currency gained almost three per cent during the previous two weeks.

Hedge funds and other large speculators increased net futures positions that profit from yen gains against the dollar to 37,653 contracts as of January 19, the most in three years, according to Commodity Futures Trading Commission data.

JPMorgan Chase & Co.'s Global FX Volatility Index reached 10.8 per cent this week, the highest level since September.

Dollar strength

The Bloomberg Dollar Spot Index, which tracks the dollar against 10 currencies, rose 0.3 per cent, reaching the strongest level in more than a decade. The measure has gained 1.9 per cent since the Fed's December rate increase.

The US central bank is forecast to keep its federal funds rate target unchanged at 0.25 to 0.5 per cent and investors will study the policy statement for hints at longer-term trends. Policy makers have signalled they may raise rates four time this year, while traders are betting on only one increase, with the China-led global slowdown calling into question the need for further monetary tightening.

Strategists in a Bloomberg survey forecast the dollar to strengthen to $1.05 against the euro in 2016, the smallest annual advance since the dollar appreciation cycle began in 2014. The US currency is projected to strength to 125 yen, according to a separate survey.

"It's going to be very challenging for the Fed to convey a message that satisfies both the doves and the hawks," said Peter Dragicevich, a foreign-exchange strategist at Commonwealth Bank of Australia in London. "If they don't express some concern around volatility, the market could see that as them being more hawkish, but again, if they change tack, the market could say that they're trying to justify market pricing and that would be more dovish."