As the markets gear up for the Federal Open Market Committee (FOMC) decision, there’s a notable trend developing in foreign exchange (FX) markets, particularly surrounding the U.S. dollar (USD). Traders are largely biased toward selling any upticks in the USD, with this sentiment being especially clear in the USDJPY pair. Here’s a breakdown of the current market dynamics.

USDJPY Moves Sharply

On Tuesday, USDJPY saw significant movement, with a more than 100 basis point (bp) swing. This has been one of the most active areas in FX, with many institutional players looking to sell into strength, or “sell pops,” when the USD gains against the yen.

Among the macro trading community, there’s been a strong preference for positioning further downside risks in a leveraged manner. These trades have often come in the form of exotic options (EKOs) and digital options (digis), which offer high leverage and payoffs tied to precise levels or events. This approach signals a broader expectation of further USD weakness.

Duration Selling Fuels USD Capitulation

The broader environment has seen duration selling – selling off longer-term bonds – contributing to a supportive backdrop for the USD’s decline. As duration sells off, yields can rise, but in this case, it seems to be feeding into broader USD weakness ahead of the FOMC.

Fed Rate Cut Speculation

Market participants are currently split between whether the Fed will deliver a 25bp or 50bp rate cut. This 50/50 market positioning is visible in the USD Overnight Indexed Swap (OIS) market, which ended the day showing an even split between expectations for the size of the rate cut.

This ambiguity is leading to a lightening of positions, with traders reluctant to hold excessive USD exposure ahead of the FOMC announcement. The market remains inclined to price in further easing from the Fed, with traders front-loading their expectations for rate cuts.

Gamma Trading and USD Bias

In the options market, the gamma space has seen consistent bids at the front end. Gamma trades, which are focused on the near-term volatility of options, show that market players expect heightened volatility but are still leaning towards USD weakness as the dominant directional bias.

Event Risk Leading Into the FOMC

As the FOMC approaches, the overall event risk has increased. With a growing number of traders reducing their exposure to USD, the market is bracing for any surprises in the Fed’s decision or communication. This uncertainty is playing out in FX options, which remain elevated in pricing volatility.

EM Asia FX Impact

In emerging market Asia, FX liquidity has been particularly thin due to local holidays, but the trend remains consistent. Clients are still inclined to sell any USD strength in the region, particularly in USDAsia currency pairs. Many are using this quieter period to position more aggressively for a weaker dollar, further emphasizing the global sell-off sentiment around the USD.

USD Weakness the Dominant Market View

As we head into the FOMC decision, the prevailing sentiment across FX markets remains tilted towards selling any USD strength. Whether it’s through USDJPY or emerging markets like Asia FX, traders are looking for opportunities to capitalize on what they see as an inevitable continuation of USD weakness. With rate cut speculation on the rise and event risk looming large, it’s clear that most are preparing for more downside in the dollar.