USD/JPY wavers around 132.50 mark, as market braces for Fed action

• USD/JPY holds steady near 132.50 amidst softer US Treasury bond yields.
• Banking developments boost risk appetite as Fed decision looms.
• Inflation remains the primary battle as Fed grapples with banking turmoil.

USD/JPY hovers around the 132.50 level amid softer US Treasury (UST) bond yields and calmer US futures. On Tuesday, US Treasury Secretary Janet Yellen addressed a group of bankers, suggesting that the federal deposit guarantee could be extended to all small banks in the US.

These suggestions come after the Federal Reserve (Fed) made synchronized efforts to inject liquidity into the US market through swap lines and discount windows. Such actions have been reflected in the Fed's balance sheet as a spike occurred amid ongoing quantitative tightening. These actions have eased some banking concerns, resulting in a risk-on environment on Tuesday.

Developments on the banking front have led investors to expand their risk appetite to digest another 25 basis point (bps) rate hike from the Fed on Wednesday. Markets are pricing in an 85% chance of a 25-basis-point rate hike when the Fed announces its monetary policy decision. The peak for the Fed's benchmark overnight interest rate was seen at 5.5% only a few weeks ago, compared to around 4.8% now.

Rapid action in the banking sector has refocused the Fed on the inflationary path, as it remains well above the 2% target. The main battle is likely to be with inflation. The Fed has clearly shown that if required, they can fight on both fronts while keeping the hiking cycle intact and easing if necessary.

Any deviation from the expected 25 bps rate hike by the Fed could spark extreme volatility, which is very unlikely. Since the summary of economic projections was conducted prior to the banking turmoil, attention will shift to the dot plot, policy statements, and press conferences.

Earlier comments from Japan's Chief Cabinet Secretary Matsuno indicated, “Will allocate more than 2 trillion Japanese Yen from reserves for measures to cushion the blow to the economy from rising prices.”

Levels to watch