Synopsis:

BofA views this week’s FOMC as a relatively benign event for FX markets, with greater volatility stemming from White House messaging on trade policy. While no policy move is expected, Chair Powell’s interpretation of recent data and potential tariff impacts will attract attention.

Key Points:

1. FOMC as a Placeholder:

   • The January FOMC is seen as a "placeholder" meeting, with implied odds of a policy move essentially at 0%.
   • Markets expect no major shifts in guidance, following the Fed’s hawkish December meeting, where 2025 rate cut expectations were scaled back.

2. Economic Data Context:

   • Since December, labor market data has surprised positively, while inflation readings have softened.
   • Inflation expectations, particularly from the University of Michigan survey, have ticked up, reflecting concerns about potential tariff impacts.

3. Chair Powell’s Messaging Crucial:

   • Powell has shifted from dovish in September (50bp cut) to hawkish in December, and his tone will shape USD dynamics.
   • Powell previously noted that some FOMC members incorporated expected White House policy changes, such as tariffs, into their forecasts. Markets will scrutinize how Powell articulates the expected impacts of these policies going forward.

4. Trade Policy Takes Center Stage:

   • FX volatility remains more driven by uncertainties surrounding trade policy than immediate Fed policy moves.
   • Governor Waller’s recent sanguine stance on the inflationary effects of tariffs could signal less urgency for aggressive Fed action.

Conclusion:

The January FOMC is expected to have limited impact on the USD unless Chair Powell surprises with his outlook on trade policy or its integration into the Fed’s forecasts. For now, the USD’s trajectory will likely remain more influenced by developments in trade policy than the Fed’s near-term guidance.