The market is shrouded in a 32-hour central bank battle, traders are worried

After major economies sent conflicting signals disrupting the market, investors are eager at the beginning of this week to find answers regarding the recent path of global monetary policies.

Traders will be striving to explore whether the Bank of Japan will raise interest rates, and when and by how much the Federal Reserve and the Bank of England will cut rates. This relates to the recent surge of the yen and pound, as well as the decline in short-term U.S. Treasury yields. Due to uncertain policies and economic growth prospects, multiple markets appeared nervous at the end of last week.

Wong Kok Hoong, Head of Stock Sales Trading at Singapore's Maybank Securities Pte., said, "This week will be more interesting. Perhaps more tiring too."

Here is a trading guide for central bank actions this week:

Bank of Japan

On Wednesday, the Bank of Japan will announce its interest rate decision and outlook report. The Bank of Japan has rarely adjusted interest rates over the years, creating uncertainty in the market about what actions the Bank of Japan will take this week.

Bank of Japan Governor Haruhiko Kuroda set a personal record of not making public comments before the policy meeting, and the latest economic data shows accelerating inflation but disappointing consumer spending.

The assumption of further policy tightening has led to a rapid rise in the yen last week. Since July 11, the yen has risen by about 5% against the dollar, partly due to authorities growing tired of currency weakness and suspected interventions.

Last week, bets on a rate hike by options traders surged from below 40% to close to 90%, then stabilized between the two, highlighting the uncertainty.

According to Bloomberg's latest survey, economists are also uncertain, with only 30% predicting a rate hike, but over 90% of economists see the risk of a rate hike.

Through carry trades (borrowing yen to purchase high-yield assets), the yen is interconnected with a large amount of leveraged investments, indicating that sharp fluctuations will quickly spread to global markets. The recent surge in the yen has disrupted popular currency strategies from the Australian dollar to the Mexican peso.

Kuroda's inaction would weaken yen long positions, especially if expectations of a significant reduction in bond purchases are also disappointing. However, if the Federal Reserve takes any action this week, raising hopes of a rate cut in the U.S. in the coming months, yen short positions will be threatened.

Charu Chanana, Forex Strategy Head at Saxo Capital Markets, stated:

"I still stand on the yen short side, despite significant two-way risks in this week's big move. Expecting the Bank of Japan to raise rates and adjust bond purchases at the same meeting seems a bit far-fetched for a fundamentally dovish central bank."

Federal Reserve

At 2 a.m. Beijing time on Thursday, the Federal Reserve will announce its interest rate decision. Half an hour later, Fed Chair Powell will hold a monetary policy press conference. Investors will carefully study the Fed's policy announcement and Powell's speech, looking for any information supporting expectations of the first rate cut in September If the Federal Reserve really signals a rate cut in September, it will be in line with the views of economists and swap traders, who fully believe that there will be at least two 25 basis point rate cuts this year. The Fed's benchmark interest rate is currently between 5.25% and 5.5%, which was the peak reached a year ago.

In recent weeks, policymakers have been pointing out the balance of the labor market and the fading of inflation, indicating that they believe the reasons for the world's largest economy to cut interest rates are becoming more compelling.

"The upcoming FOMC meeting will set the stage for a rate cut in September, as the Fed has reason to shift its policy from a restrictive area to a more neutral stance," said James Knightley, Chief International Economist at ING.

From former New York Fed President Dudley to market observers like Mohamed El-Erian, some have even proposed more aggressive easing policies than currently expected. Dudley suggested in Bloomberg Opinion columns that the Fed should consider cutting rates this week, while El-Erian warned that if the central bank keeps rates too high for too long, there will be a "policy mistake."

U.S. Treasuries are expected to achieve a three-month consecutive increase by the end of July, the last time this happened was in mid-2021. The growing belief in rate cuts has helped the Bloomberg U.S. Treasury Index reach a two-year high this month. The yield on the two-year Treasury has declined in anticipation of loose monetary policy, narrowing the gap with the 10-year Treasury yield.

However, the U.S. stock market is somewhat shaky, partly due to doubts about consumer strength raised by some corporate earnings reports. The S&P 500 index previously set a record for the longest period without a 2% decline since the global financial crisis erupted in 2007, but that record ended last Wednesday.

Just look at the volatility market to see how important this week is for traders. This week will also see the release of the U.S. jobs report, as well as earnings reports from companies like Meta Platforms, Microsoft, and Apple.

The indicator of implied price volatility for the S&P 500 index this week has surged nearly 1 point higher than the expected volatility two weeks later, indicating that the current uncertainty is higher than future uncertainty.

Bank of England

On Thursday evening, the Bank of England will announce its rate decision, meeting minutes, and monetary policy report. There is a division in the market on whether the Bank of England will announce its first rate cut since the pandemic on Thursday, lowering the rate from the current 5.25%.

Although the inflation rate has dropped from double digits a year ago to the Bank's 2% target, the unemployment rate has also risen, but price growth in the service sector remains high, and the economy has rebounded from a slight recession. In April, the minimum wage was raised by 10%, and the new Labour government plans to provide above-inflation pay raises to up to 5 million public sector workers while raising the minimum wage, all of which bring upward price risks. Since the July election, three hawks in the Monetary Policy Committee have raised objections to easing. Only one of the two doves has made the opposite argument Regardless of the outcome, this decision could have an impact on bonds and the pound. Last Friday, the pricing of swaps indicated a 50% chance of a 25 basis point rate cut this week, with the likelihood of two rate cuts this year almost certain.

Economists believe the Bank of England will pivot. Bank of America, Deutsche Bank, Nomura Holdings, and ING Group expect six members to support action. Bloomberg Economics also predicts a rate cut.

Orla Garvey, Senior Portfolio Manager for Fixed Income at Federated Hermes Limited, said, "In terms of key data points, the Bank of England meeting on August 1 is a very important meeting with the latest forecasts."

A rate cut will boost UK government bonds, with the prospect of loose monetary policy and hopes of political stability following the Labour Party's overwhelming victory in the election already lifting UK government bonds. Yields on two-year bonds have reached their lowest level in over a year.

For the pound, a rate cut is not as favorable as it would reduce its attractiveness as part of carry trades. The pound is currently the best-performing currency among the G10 this year, with major banks and investors such as Morgan Stanley and Amundi predicting the pound to rise further against the dollar to 1.35, a nearly 5% increase from current levels. Bullish bets have reached historic highs.

Bloomberg Macro Strategist Cameron Crise said, "Unsurprisingly, recent market turmoil has sparked a narrative backlash related to positions in stocks, fixed income, and other markets. It may be dangerous to say so, but in some ways, this time is indeed different from what we have seen before."