USD/JPY: Modest Gains As Markets Eye Fed Announcement

 | Dec 18, 2013 07:20AM ET

USD/JPY has edged higher in Wednesday trading, as the pair is once again close to the 103 level. Taking a look at economic developments, Japan racked up a higher than expected trade deficit in November. In the US, the Federal Reserve concludes a critical two-day policy meeting on Wednesday, and the markets are anxiously waiting to see if the Fed tapers QE. As well, the US will release Building Permits, a key event, later in the day. There are no releases out of Japan on Wednesday.

Japan's trade balance pointed to another trade deficit in November. The deficit rose to -1.35 trillion yen, up from -1.07 a month earlier. The widening gap is largely due to the weakening yen, as imports became more expensive. There was better news on Monday, as the important Tankan indexes impressed. The Tankan Manufacturing Index jumped to 16 points, up from 12 points the month before. This edged above the estimate of 15 points. The news was particularly welcome, as recent Japanese manufacturing releases have not impressed. The Tankan Non-Manufacturing Index did even better, improving from 14 to 20 points, well above the estimate of 16 points. Both indicators registered their best numbers since 2007, another indication that the Japanese economy is slowly heading in the right direction.

All eyes are on the Federal Reserve, which wraps up a two-day policy meeting son Wednesday. Speculation is swirling that the Fed could announce a tapering of QE. Currently, the Fed is purchasing $85 billion in assets every month, and a Fed taper will likely boost the US dollar against the major currencies. Even if the Fed doesn’t announce a scale down of its asset-purchase program, it could provide a broad hint that tapering is imminent, or provide a sweetener such as a reduction of the interest paid on reserves (IOER). Any of these options would likely result in the dollar gaining ground. However, if the Fed decides not to change current policy, the markets will be disappointed and the dollar could fall. Whatever the Fed chooses to do, we can expect some volatility from the US dollar following the Fed announcement.

Meanwhile, a two-year, bipartisan budget agreement is moving quickly through Congress. The deal was overwhelmingly approved in the House of Representatives last week and the Senate is  expected to follow suit on Wednesday. The agreement sets limits on government spending for two years and reduces the deficit by a modest $23 billion. Democrats and Republicans both had criticism of the proposal, but there is general agreement in Washington that the compromise reached is a positive step which removes much of the fiscal uncertainty we’ve seen in recent months.