Opinions

Global macro-outlook has turned +ve for Dollar. USD is benefitting from: 1. Carry/ Terms of Trade 2. A more balanced Fed 3. Firmer domestic data 4. Renewed US equity strength. Shifting terms of trade have dictated FX returns in recent months. These ToT shifts should lead to diverging growth outcomes, which have started to become clearer in recent activity data, including the sharp downside surprise in China April activity data and the deceleration in the May flash PMIs for Europe. While there are a number of important exceptions, like CNY and commodity-intensive exporters, the net effect of the AI boom and higher-for-longer energy prices leaves the US looking like a relative outperformer once again. Also the situation in the Middle East which is not mending itself as many would have assumed a month or so ago. Signs that the Hormuz strait will stay clogged for longer can only exert upward pressure on oil prices – with the dollar gaining 0.5-1% per 10% of higher oil prices in our estimates. From the perspective of US macros itself. the US labor market is showing more signs of demand stabilization after months of softness weighed heavily on the USD. US inflation upside surprises are re-emerging, challenging expectations of limited pass-through to core inflation. US equities are in the midst of one of their great ~2m runs ever reinvigorating the notion of dollar-positive US exceptionalism via strength in the tech sector. USD OIS curve is still meaningfully lower than the G10 average. This could narrow two ways - by 1) depricing RoW hikes, or 2) if US rates continue to creep higher on growth/inflation/Fed signalling. On Euro itself, we’ve a bearish-EUR/USD forecast & now expect a range of 1.12-14 in H2CY26. The Euro is among the lowest yielders globally, growth momentum has substantially worsened vs the US, relative ToT deteriorated sharply. The real yield differential has narrowed further, completely reversing the improvement post-German fiscal u-turn in March 2025. On JPY, we remain bearish and believe if not for intervention, JPY might have breached the crucial 162 levels. On GBP too, we remain bearish & see 1.30 levels sooner than later considering last week’s set of poor data & continued political uncertainty. Only AUD & CNH might remain insulated from DXY strength as AUD gets supported by commodity strength & CNH has a high current account surplus supporting it’s resilience. To summarise, we now see DXY moving towards 102 levels in H2CY26 if 98 holds on the downside. DXY is currently at 99.25.

USD/JPY finally breached 158 to the upside last week, closing at 158.74. There was no strong evidence of MOF’s interventions around 158. We believe market interventions can only delay the inevitable as FX fundamentals have not yet tilted toward USD/JPY downside because: 1) Oil remains elevated, leading to the rise in USD. 2) There are no strong signs of Japanese investors’ repatriation. 3) Japanese fiscal policy uncertainty increases, owing to news reports on the supplementary budget. Bessent might not want any UST redemptions from MoF in the current rising US bond yield environemnt, hence the support for JPY intervention. But crude remains elevated with brent closing 109+ last week. We estimate a potential maximum impact of JPY 6trn deterioration in Japan's trade deficit if Brent remains around 105-110. This amounts to a 5-6% depreciation in JPY. Even on capital flows, while equity inflows remains strong, bond outflows continue to remain elevated resulting in a net neutral picture on flows. JGB yields continue to soar with 30yr JGB above 4% (first since 1999) finding no love from local lifers. While we see June hike as very likely, the bar for BOJ to outhawk current market pricing is very high. For e.g. the 2yr forward 1yr swap rate which can be viewed as one proxy for the terminal rate — has already risen above 2%. This is above the midpoint of the BOJ's estimated neutral rate range in nominal terms, and depending on the estimate used, is already in restrictive territory. But it is unlikely that hiking to such levels represents the consensus view among BOJ Policy Board members. Furthermore, market skepticism regarding coordination between the government and the BOJ is likely to persist, which will likely weigh on the JPY. In summary, we believe JPY might remain headed towards 162. Any intervention is unlikely to make it rise above 156 levels. To break above 162, JPY needs 10yr UST around 4.85 & Brent above 120. On the upside 156 is the level below which JPY can sustain only if BOJ turns distinctly hawkish or Brent falls below 90. But with DXY finding strength last week, we expect a retest of 162 before 156.

While the middle east conflict continues for it's 36th day, financial markets are currently focused on the near term inflation impact of higher crude prices. But medium term growth might suffer more than inflation. Stagflation risks continue to rise sharply, presenting a dilemma for the world’s central banks. USD continues to recover, but the gains have been muted, and FX volatility has been relatively contained compared to commodities and rates. We expect the USD to be supported on risk aversion and higher energy prices, but we also see considerable performance dispersion under the surface. The Asia FX outlook remains broadly bearish given the region’s vulnerability to the oil shock. Headwinds include a sustained rise in energy costs, elevated short-term US interest rates, the compression of growth differentials versus the US, and an unfavourable capital flows picture. Even if the US leaves the war without any further escalation in the coming weeks, a sustained positive reaction in risk markets (and a softening of the USD) is questionable, barring a further decline in oil prices (e.g., the Strait of Hormuz begins to re-open). Without this, the elevated oil price backdrop would continue to adversely affect global growth, drive inflation higher and likely pressure BoP dynamics (i.e., trade account deterioration; portfolio outflows on the negative growth outlook) across most of the world. On a de-escalation narrative, there will initially be risk premium repricing followed by more fundamental considerations such as lost growth, lost trade & lost capital flows. But will de-escalation lead to the resuming of pre war dedollarisation theme. It might but for different reasons. Central bank divergence risks in H2CY26 might halt the current DXY bull run. If this divergence is meaningful which we believe might be a strong possibility, (our view: ECB & BOE hiking by 50 bps total in H2CY26 while Fed cuts by 25 bps) then DXY might see another meaningful correction in H2CY26. Hence our short-term view target for DXY is 102 with stop around 98 (CMP 100). But we don’t expect DXY to sustain above 102 for long in medium term.

The Dollar saw a muted depreciation against a broad range of currencies on the Supreme Court’s tariff decision. We see some potentially important positive channels that could eventually overturn the initial negative USD reaction. The small decline in the effective tariff rate should provide a positive impulse to growth, and the new restrictions imposed by the Court could help recoup investor confidence and narrow the perceived scope of potential policy changes ahead. We believe that after SCOTUS rolling back of IEEPA, tariff uncertainty levels will come down. Hence the policy risk premium should also subside. SCOTUS ruling show that the rule of law still exists in US policies towards the RoW. Also it’s notable that, even if tariffs are continued via other Sections, they will lack the flexibility of IEEPA in a way that might constrain the administration's ability to use tariffs as a tool of leverage (eg the % tariff applied under Section 122 must apply equally to all parties). 301, meanwhile, has flexibility but again requires investigations at the country/product level. In essence, this could reduce US policy risk premium applied in FX and could also help lessen tariff volatility over the medium-term (both threatened and realized) compared to 2025. US growth looks set for another stellar year after significant productivity growth, stabilising employment environment as well as strong earnings growth from US equities. The hawkish Fed minutes imply that there are no rate cuts till May as long as Powell stays as Fed Chair. The first mention of Fed hikes in this cycle in the January minutes is a notable development and an important risk to monitor this year. Hence we should not write dollar off yet. The biggest loser in case of a dollar rally might be JPY as there has been no obvious signs of Japanese repatriation flows. The recent strength in the Yen and the long-end JGB rally following the LDP’s landslide election victory (in addition to more frequent risk wobbles) have sparked renewed focus on potential repatriation flows from Japanese investors. Our metric, based on the monthly ITS report, continues to suggest still-steady demand for foreign assets through January 2026. Looking ahead, we continue to think that significant repatriation flows by unhedged investors would likely require a much narrower rate differential. As a result, we think investors looking for a notable shift from Japanese investors towards domestic assets are likely to be left disappointed over the nearer term.

The LDP’s landslide victory in the Lower House election has strikingly sparked a different market response than going into the event. Since Takaichi's landslide victory, the 5s30s curve has flattened, traded inflation is stable, and the Yen has strengthened, as the market is now pricing some higher likelihood of shifting portfolio flows and an exit from the exceptionally low real rate regime. We think current conditions can run further given the balance of risks and momentum into a vacuum over the next few weeks, but our bias is that this is potentially ‘too much too soon’. We are not convinced of the market’s characterisation of PM Takaichi as a policy hawk. Market optimism on Japan assets may get a reality check with clarity on BoJ nominations, budget talks. The likelihood of significant repatriation flows also looks low to us over the near term; recent Japanese portfolio flow data and the factors that often take precedence for key investor groups in Japan indicate that, for such flows to occur, we would likely need to see a much narrower rate differential or an even steeper JGB curve. From a flow perspective, last week, USD/JPY recorded the largest downside demand in about a year. 22% of USD/JPY puts transacted post-election featured strikes below 150. JPY still flags as short vs USD in absolute terms, and also relative to peers suggesting more room for short covering. The 1m flow metric is quickly mean-reverting lower after this week, suggesting short covering, and doesn’t suggest the market has pivoted to net long yet. Indeed, JPY still screens as the most-short / least-long currency broadly on the cross-section as well. Summary: To be clear, we do not rule out a further rally in the JPY. The lacklustre reaction in USD-JPY, despite impressive US nonfarm payrolls data, suggests that the JPY has benefitted from market bearishness on US assets. But we also think that Japanese assets may get a reality check once more clarity emerges on BoJ nominations and the fiscal policy stance as budget deliberations resume in early March. Takaichi’s strong mandate could also open the door to unconventional policy measures. For now, the short-term range on JPY still remains 152-160. The stairway towards 140 is still hazy.

Historically United States and other countries have always made complaints that China keeps the value of the RMB artificially low, boosting its exports and trade surplus at the expense of trading partners. US has consistently pressured China in the past decade to allow the RMB to appreciate at a faster pace, and to let the currency fluctuate more freely in line with market forces. Cut to present, since CNY broke through it’s 31 month low of 7.00 on 29th Dec, the Chinese currency has now strengthened by 1.4%. That does not sound like a strong appreciation but the fact that it is allowed to happen by Chinese policy makers makes us wonder about their motivations and what is the eventual destination for RMB. From a policy perspective, Xi wants to build an alternate global reserve currency, hence RMB has to be seen as aiding China’s trade partners & not the past pattern of export competitiveness. This has pushed PBOC to allow a gradual appreciation in RMB to current 6.90 levels. But we see an impending flow issue which can move RMB in a non linear manner to 6.5. China created 1.2 TN USD trade surplus in CY2025. We observe that a vast pool of US dollar cash has accumulated in Hongkong. In just two years US dollar deposits in Hong Kong banks have grown by $325 BN to $1.5 TN. Net foreign exchange purchases by Chinese onshore banks amounted to just $197 BN, less than the growth of US dollar deposits in Hong Kong over the same period. The 1.4% rise in RMB against the USD since end CY25 has already eroded most of the yield pick up that Chinese holders of US dollar deposits expected for this year. Now RMB based holders of US dollar deposits have to face the prospect that at this rate of appreciation, it will only be a matter of weeks before they are losing money on their positions. Hence, we expect these US dollar deposits in Hong Kong to start moving inwards to RMB if RMB sustains below 6.85. This will lead to a avalanche of RMB buying further leading to a nonlinear movement towards 6.5. Both from political point of view as well as flow point of view, RMB looks headed to 6.5 levels sooner than later. We have had the same view in many of our earlier fx opinion pieces since RMB was at 7.10. Now with PBOC reluctance to halt the appreciation, our view stands vindicated.