Participants across the equity, fixed income, and currency markets are holding their collective breath this morning, with many waiting for this afternoon’s rate decision from the Federal Reserve to provide clarity before adjusting positions. Stock markets are setting up for a steady open, 2- and 10-year Treasury yields are virtually unmoved, and the dollar is little changed. Oil benchmarks are giving back some of yesterday’s gains.

Prices rose significantly less than expected in the UK last month, giving the Bank of England some breathing room ahead of tomorrow’s rate decision. Numbers published by the Office for National Statistics this morning showed the headline inflation rate slowing to 6.7 percent year-over-year from 6.8 percent in July, with a rise in gasoline costs failing to lift the gain above the 7 percent expected in markets. Core inflation, which in the UK excludes food, energy, alcohol and tobacco, hit 6.2 percent in August, down dramatically from 6.9 percent the previous month. Overall month-over-month increases slowed to a pace relatively consistent with the central bank’s target. Odds on a quarter-point rate hike plunged from around 80 percent to around 50, gilt yields tumbled, and the sterling fell against the dollar as traders bet policymakers would seize on any opportunity to avoid tipping the economy into recession by raising rates too far.

Canada’s loonie is slightly softer, with yesterday’s knee-jerk reaction to a hotter-than-anticipated inflation print gradually fading over time. The exchange rate surged toward early-August highs yesterday morning as price growth topped forecasts and lifted the likelihood of a final rate hike in the Bank of Canada’s tightening cycle, but a speech from Deputy Governor Kozicki later in the day helped dampen market enthusiasm. “Both inflation and inflation expectations have come down, and excess demand in the economy is easing,” she said, “our past policy actions will continue to have an effect as they work their way through the economy”.

We remain convinced that the Bank has reached the end of its hiking campaign, and think rate forecasts should shift downward – into closer alignment with the Fed’s expected trajectory – in the coming months as the economy slows.

The yen, in contrast, is slightly firmer this morning – albeit at extremely low levels – after intervention efforts gained verbal support from Masato Kanda and Janet Yellen. The Japanese vice minister of finance warned authorities “will not rule out any options in dealing with excessive foreign exchange fluctuations,” and said “We’re in very close communication with the US monetary authorities and share the view that excessive volatility is undesirable”. The US Treasury Secretary said “We usually communicate with them about these interventions and generally understand the need to smooth out following undue volatility, but not attempt to influence the level of exchange rates”. With the Bank of Japan set to release its latest – likely unchanged – decision on Friday, traders are braced for more jawboning efforts from Governor Ueda.

The Fed is expected to leave its major settings unchanged and keep the possibility of a late-autumn rate hike alive in this afternoon’s decision, but traders are, frankly, rather uninterested in what the central bank says about its short-term policy direction. That officials are on a data-dependent footing amid incredibly uncertain conditions is well understood, and expectations don’t have far to move with implied odds on a final 2023 hike already sitting close to the 40-percent mark.

But the “dot plot” – the summary of official estimates for future growth, inflation, and policy rates – could trigger renewed turmoil in fixed-income and currency markets. If policymakers grow more confident in a “soft landing” and more concerned about persistent inflation pressures, the four rate cuts previously pencilled in for 2024 could be revised down to three, forcing yields higher and squeezing dollar shorts. Alternatively, a still-dovish outlook might unleash a rally in equity markets and send the greenback tumbling toward the middle of the “dollar smile”.