Opinions

DXY has declined in eight of the past 10 Decembers (average: -91bp) but will this December be any different? Since 21st Nov, when New York Fed President Williams spoke about the space for cutting rates in near term, DXY has languished against major DM FX. DXY has fallen from 100.3 around 21st Nov to 99.45 levels currently. We were earlier of the view that Dec FOMC might be a hold because of lack of data but seeing the Willims comment and current market pricing which Fed might not want to surprise, we accept the possibility of a cut of 25 bps. But we still believe this will be a hawkish 25 bps cut stressing that the inflation gap matters more than the unemployment gap based on financial conditions being “loose” because equities are high and credit spreads are tight. It would stress that neutral is above 3%, that policy is only “modestly” restrictive and that future moves depend on “incoming data” rather than the clear deterioration already visible in labor market readings and credit access. Markets would read that as one-and-done or, at best, a much shallower future path of easing until new leadership/personnel is established. Front-end yields would stay elevated in real terms; the dollar would rally and the risk premium on equities and credit would need to rise to compensate for the Fed being behind the curve on labor markets. We like DXY long against EUR & JPY. We believe BOJ has enough reasons for hiking by 25 bps in it’s 19th Dec meeting due to sustained elevated inflation profile but it might wait till it’s 31st Jan meeting to see the Shunto wage negotiation results. In addition PM Takaichi expansionary policies might force Ueda to skip hike in the Dec meeting. We see JPY testing 160 in December as BOJ again fails to hike. We look for EUR to test 1.1475 levels in Dec as Fed does a hawkish cut & Russia Ukraine peace talks fail to come to it’s logical conclusion. Amongst DM FX, we are relatively bullish on GBP against EUR for the month of December. Short GBP positions had been popular going into the budget, and these are likely to see some unwinding on the avoidance of the major negatives. We like to sell EURGBP around .8800 and .8850 levels for an eventual fall to .8680 levels. We also like NZD & target .59 levels from the current .5735 levels. Following the hawkish RBNZ 25bp rate cut this week and further strong economic releases it appears that the market is swinging hard towards an upswing in NZD. To summarise, we believe sticky US inflation will likely limit the FOMC’s ability to give a neutral 25 bps cut in Dec policy. Hence even if there is a 25-bps cut, it will be accompanied by hawkish press conference from Fed Chair Powell. This will be the compromise which Powell might work out to reach a consensus though we still believe a rate hold can’t be ruled out. We also believe liquidity towards non dollar assets might be soon drying up due to elevated supply in better yielding investment grade dollar corporate bonds and this too should support DXY. US seems to be the cleanest shirt in town considering it’s relatively better growth profile than both EU & UK. Hence DXY rebound should get aided by growth differentials too.

We see the USD backing up in Q4 till employment data decidedly turns worse. We also expect a more hawkish Fed to current market expectations. Though we ourselves believe employment data should turn out weak and Fed should continue cutting, recent Fed speak looks heavily stacked against a Dec cut in absence of US macro data. With terminal rate pricing for US moving to 3.10-3.15 band, DXY should strengthen soon in short term. Major losers could be EUR & GBP. We also like the fact that USD has historically tended to rebound with the end of government shutdowns, albeit with a short lag, perhaps as the resumption of public spending and back pay supports economic activity. But we also concede that the path toward USD strength could be non-linear as the market swings from excessive concerns about labour-market cooling to exuberance over strong US economic momentum. If by 10th Dec, Fed is able to get the Oct & Nov NFP data which we believe might be weak, Fed will be forced to go for a cut but Fed chair Powell will ensure it ends up as a hawkish cut. We also expect Q3 US GDP data to be strong; the Atlanta Fed nowcast points to 4% growth on a seasonally adjusted annual rate (saar) basis. There could be downside risks to the USD from the Supreme Court hearings on the legality of US tariffs though dropping the tariffs would essentially eliminate what many view as a sales tax on imported goods, so it could end up being somewhat stimulatory. On EUR, we see Q4CY25 ending at 1.15. We have found no evidence of sustained buying by reserve managers to explain the EUR’s recent outperformance; this is also in line with the IMF’s findings. On GBP, we see Q4CY25 ending at 1.3. The UK economic backdrop remains poor, evidenced by a loosening labour market, easing wage growth and sluggish economic momentum in Q3. Recent policy confusion on tax hikes further adds to GBP underperformance against DXY. On JPY we see Q4CY25 ending at 155+. Market continues to test the Ministry of Finance (MoF)’s tolerance for JPY weakness, with BoJ rate hikes perceived to be on the back burner. Our base case remains that the Bank of Japan will hike rates in December, but we see a growing risk that it defers policy tightening to 2026. Prime Minister Takaichi recently staffed the Council on Economic and Fiscal Policy with policy makers who favour reflationary fiscal and monetary policy, and reiterated that Japan has not exited deflation yet, further underscoring her implicit opposition to BoJ tightening. On AUD, we are positive & expect Q4CY25 to end at .66. The market has added to AUD longs via AUD-NZD (which briefly breached the 1.16 level). With Australia’s economic recovery underway, consumer confidence rose in November to the highest since level end 2021. In addition commodities strength & CNH appreciation tendency support AUD.

A combination of political surprises in Japan and France have led to weakness in both the EUR and JPY over the past week, with market concerns over their fiscal policies/debt dynamics. This has led to a sharp upswing in DXY in the past week. This is against the dominant sell dollar macro theme evident during much of CYTD25. Also comments from Federal Reserve officials urging caution around further interest-rate cuts have also supported the recent dollar upswing. Our analysis of the French political landscape implies Lecornu’s second government will face tremendous challenges in getting the budget passed and may throw in the towel if it can’t obtain a majority for the State’s budget or the Social Security budget in the coming weeks. That would force Macron to appoint yet another PM or consider a snap election. In either of the above two scenario, we see EUR testing 1.14 levels from the current 1.16 levels. W.r.t Japan, with the exit of Komeito party from LDP coalition, Takaichi’s path to the premiership is extremely uncertain. We see two scenarios. 1. Takaichi becomes a weakened, “lame duck” prime minister, supported only by the LDP. This could lead to greater fiscal stimulus and paralysis for Bank of Japan’s policy path. 2. The opposition (CDP and allies) unites behind an alternative candidate, possibly Tamaki. This too would favor heavy fiscal measures and paralysis at the BOJ. In both scenarios Yen and JGBs lose. So, we are now neutral on JPY and believe it might be some time before we find the top in JPY some where around 155. Our original view of it testing 140 levels by Dec’25 is not valid anymore. Combining above two views, we believe economic uncertainties in both Eurozone & Japan can only accelerate further from here. This might keep Dollar bid in short term at least for Q4CY25. With Trump announcing another 100% tariff on China over and above any existing tariffs & the Xi Trump meeting unlikely at the ASEAN meet this month end in our view, risk assets globally might be under weather leading to some bid for Euro & JPY. But the resultant impact might not be enough for DXY to keep testing the crucial 99.50 levels which is the 23.6% retracement of the entire move between 110 & 96.3 for the last 1 year. Once it breaches 99.5 on a daily close basis, we can expect more upside towards 101.60.

Foreign buying of US assets have returned in Q2CY25 both in equities & debt. For equities, the data indicates that foreigners stepped up big-time, buying almost $300bn after barely buying in recent years. On the debt side, foreigners bought $200bn in Q2 (one-third of the total net issuance), though this was a little lower than the pace of recent years. Foreigners now own 18% of US equities, a record amount. They own almost a quarter of US debt securities, having been buyers of a third of net issuance in the past couple of years. But these inflows are significantly hedged now than before. For the first time this decade hedged US inflows are now dominating over unhedged exposure. The shift is exceptionally stark in equities (more than 80% of inflow is now hedged), but also very apparent in bonds (around 50%). Some investors have lifted hedge ratios for existing holdings also. Increased hedging could be the simple first option - there may still be reallocations away from the US to come. The FX implications are clear: foreigners may be buying US assets, but they don’t want the dollar exposure that goes with it. For every dollar asset that is bought, an equivalent amount of currency is sold to remove the FX risk. It is only unhedged inflows that finance the US current account deficit and these are running 75% below the peak from last year. The dollar is falling because the unhedged flow picture looks very weak. With the Fed about to start cutting rates while most other central banks are on hold, hedging dollar assets will only get cheaper. The improvement in the flow picture has arguably removed some of the extreme tail risks that would have resulted from a complete absence of inflows. Uncertainty about the underlying steady state of demand for US assets remains high however. In the mean-time the underlying cyclical support for the dollar has deteriorated, reflected in a material narrowing in the EUR – US rate differential which is now consistent with a financial fair value in EUR/USD in the 1.18-1.20 range. It is stating the obvious that additional Fed cuts from here would increase incentives to hedge dollar assets by foreign investors. With the dollar having in the meantime removed any excess cheapness / risk premium relating to President Trump’s policies, it still leaves the overall outlook as leaning asymmetrically dollar bearish. This can only change if the growth differential between EU & US widens which can happen in CY26 when US tax cuts come into play supporting corporate growth & Fed rate cuts aid HH BS. But by then German fiscal stimulus will also be in play. So, it’s a complex play in CY26 but at least for CY25 EUR bid against DXY might continue as hedging flows over power other fx determinants.

DXY has been largely range bound in July & Aug around 98-100 levels. But we think that the forces which started the fall in DXY from 110 towards current levels, are still present and in the same degree perhaps. Tariff led policy uncertainty (US Federal Appeals court declared tariffs as illegal on Friday), faster rate cut possibilities (if Aug NFP come as per our estimates at 40k) & lower US growth prospects due to lower supply of labor as well as AI capex momentum looking stretched. EUR has found it difficult to sustain above 1.17 recently for various reasons. Latest being the French no confidence vote. Historically, Euro area political risks impact the currency only when there are clear signs of contagion or a lasting impact on real activity. Both seem unlikely, in our view. Hence we should see EUR headed towards 1.20 levels by end CY25. Technically we need to have a weekly close above the 1.17 level for another up move towards 1.20 level. The star FX performer for Aug was CNY. And this came without much FX market pressure. Also when both CNY and CNH were already trading weaker than the CNY fixing, policymakers still moved the fixing stronger. Taken together with a jump in the FX conversion ratio in July, we think this shows the interplay between clear policy intentions and the response of market participants. Structurally, CNY continues to screen as significantly undervalued, with the degree of undervaluation now comparable again to the period of the “China shock” in the mid-2000s. Recent economic performance—large export market share gains and a surge in the current account surplus bode well for CNY. We believe CNY is eventually headed towards 7.00 levels by end CY25. This has important implications across FX markets, both because it takes some of the onus off the Euro to provide the Dollar depreciation impulse and because CNY is an important regional anchor for low-yielder currencies in both EM and G10. JPY on the other hand has been 147 centric for past many weeks. The ruling LDP is scheduled to hold a review of the Upper House election results at a general assembly on Tuesday. But we think the political instability is priced in already. Any weakness due to political noise should be used to buy JPY against USD as we believe PM Ishiba might not finally resign. Also, we believe that BOJ is set to hike rates by 25 bps in it’s 30th Oct meeting considering the elevated inflation profile & a US trade deal in place. Our eventual target for JPY is 138 by Dec’25. Stop to the view is 152. CMP is 147.05. AUD needs to break above .66 levels for a decisive up move otherwise is range bound between .64-.66. CAD too is range bound between 1.36-1.38 for this week. Currently at it's 50 DMA (1.3735), we see a weak NFP triggering a move lower to 1.36 levels. GBP on the other hand has significantly underperformed against EUR which we find perplexing. UK rate cut probabilities have been priced out (only 10 bps in REMCY25 & 23 bps till Mar’26) where as Eurozone we still expect another cut by Dec’25(markets pricing in only 10 bps of cut by Dec’25). We continue to remain short EURGBP as our previous trade recommendation on 10th Aug’25. Half risk short at .8655 & another half short at .8725. Profit target is .8505 and stop loss is .8770. In summary, this week’s NFP data might give further impetus downwards to DXY. The next move lower in DXY is likely to be led by CNY & JPY. With US federal appeals court voting tariffs illegal, policy confusion in US is too significant to ignore. In addition, worries on Fed independence might also push DXY lower for longer. Best bets against DXY are EUR, JPY and CNY in that order. While Sep is traditionally a bullish month for DXY but this year it is different. Even if US equities fall due to a very weak NFP, DXY might still fall because of faster rate cut possibilities. And if the NFP comes strong around median 75k no, it might still fall due to lower growth being priced in US ex AI capex spending.

Since we believe that we are headed for 75 bps cut by Fed in REMCY25 & another 50-bps cut in Q1CY26, we believe DXY weakness is here to stay. In fact, the weakness can accelerate now further. If our view is correct, the Fed cuts will be happening under a backdrop of rising YoY inflation which implies lower real policy rates. This implies lower DXY for longer at least till Q1CY26. We won’t be surprised to see even 90 levels tested on DXY by this time period but our first stop is 95. CMP is 97.85. Broad-based USD downtrend has also been re-established in Aug post the July NFP. The USD is currently in a downtrend in 7 out of the 9 USD/G10 pairs, with neutral trends vs JPY and CAD. In terms of short-term valuation, none of the G10 currencies are grossly overvalued vs the USD except for CHF. FOMC participants advocating for a more restrained pace of cuts than our baseline of three sequential 25bp cuts often note the contraction in labor supply as a reason to be less concerned. However, lower “breakeven” payrolls pace also implies a weaker potential growth rate (and lower short-term neutral), which is negative for the Dollar if it persists. Institutional governance issues, growth differentials as well as hedging requirements are other triggers for a weak dollar outlook. Our strongest bet is on JPY where we believe BOJ is set for a 25 bps hike in it's Oct meeting. Our target is 140 on JPY with SL at 152. CMP is 147. We are more bullish on GBP than EUR because rate differential wise GBP has a better chance against Dollar than Euro. Also, higher service inflation, better recent employment nos imply a slow BOE cut cycle and a higher terminal rate too. The next leg weaker in the dollar would need to come from the US side of the equation, with the next month pivotal. This could come from either (a) further softening in labour market data which culminates into the Fed turning dovish, and (b) further market concerns on Fed independence.