Opinions

We think FX should remain in a low volatility regime under a range of likely economic scenarios. On the one hand, the Dollar should be supported by solid US economic performance and bright prospective investment returns, and it is on the right side of the energy and carry themes that we think are key to the current backdrop. On the other hand, negative Dollar impulses have come mostly on the policy side. We think this back-and-forth can continue for some time. On JPY though we have been bullish for some time, post Friday's BOJ policy meet, it seems EURJPY is a better short than JPY itself. Ueda’s comments in the press conference emphasized that the Bank does not feel behind the curve, suggesting a high bar for an October hike. That, combined with the global backdrop remaining a source of downward pressure on JPY—which should persist if the Fed hikes again in October as we expect. But we still see clearer long-term asymmetry in USD/JPY downside though the time for that view is not there yet. CNY is likely to remain strong as we approach the Xi Trump summit. On a macro basis, we believe that moving China’s bifurcated economy closer to both external and internal balance would require two policy instruments—currency appreciation and fiscal support for the domestic economy. Hence, we believe that USD/CNY is eventually headed towards 6.40 in 12 months. GBP is likely to be underpinned by BOE's dovish outcome last Thursday. An under-delivery of BoE hikes should apply steady upward pressure on EUR/GBP in the months ahead, and current levels in the cross are already well below those implied by rising rate differentials. On EUR, we see it being range bound between 1.14 and 1.16 till further clarity emerges on ECB’s reaction function towards higher crude prices. While we believe Fed might hike in October, we do not see terminal rate for Fed beyond 4-4.25% in this rate hike cycle, hence the downside for EUR is limited at 1.14.

In two of our recent opinion pieces in Aug, we had detailed why the winds of change for JPY was imminent. Yen has rallied by about 3% over the course of a couple trading days, likely in part due to the rising probability of domestic policy shifts that could meaningfully strengthen the Yen, as well as the higher perceived risk of intervention following a possible “rate check” on September 2. We believe that a faster pace of BoJ hikes or signs of rotation back towards Japanese assets could keep the Yen stronger for longer even without a shift in the global macro backdrop. We will be watching the International Transactions in Securities (ITS) data for August, which offers investor-level detail on foreign asset flows, will be released on September 7 for any clues in change to inward flows. Taking both macros & flows in to account, the case to be tactically long JPY has strengthened (despite the risk of some pullback after a sharp move). But the clearer improvement in asymmetry over a longer horizon now makes short USD/JPY a more attractive hedge for pro-risk portfolios than it has been in a long time. The overarching point for us is that Japanese policymakers appear to be focused on pulling the available levers to attract capital inflows, and there is plenty of capacity to conduct additional interventions to further reduce JPY short positioning along the way. We believe there may be a fairly sizeable JPY short position that was built up after the launch of the Takaichi administration in October last year, amid concerns over the administration’s economic policies. Our estimates suggest JPY shorts amount to ¥16–17 trillion, and if this position were to be fully unwound, USD/JPY could fall to the 142–146 range. GPIF is the elephant in the room. The fact that a report on basic portfolio verification was presented at the 21st August Management Committee, can be viewed as an early sign of a potential basic portfolio change. Our estimates suggest GPIF may have been a net buyer of foreign bonds by about ¥0.9 trillion and a net seller of foreign equities by about ¥1.7 trillion. A large deviation from these estimates could serve as a signal that GPIF’s portfolio is changing. Hence the monthly flow data on 7th Sep becomes more important to understand the flow dynamics. We also estimate that even without a basic portfolio change, if GPIF were to raise the weight of yen assets (domestic equities and bonds) toward the upper end of the current range, it could generate JPY buying / foreign-currency selling flows of more than ¥30 trillion at maximum. By contrast, if GPIF were to change the basic portfolio and raise the share of yen denominated assets, it could not only generate even larger JPY-buying / foreign-currency selling flows, but the announcement effect could also trigger a significant short-covering rally in the JPY. To summarise, with US treasury intervention and Bessent’s recent remarks that BOJ has to take decisive monetary steps to combat JPY weakness, Sep hike is a done deal for BOJ. What matters now is the forward guidance and the terminal rate discussions. From a flow perspective, prospective GPIF reallocation towards domestic assets could be the game changer for JPY fortune. We remain bullish on JPY and our base case is JPY ending CY26 around 152 levels. Best case could be 145 by end CY26 and worst case around 155 by end CY26. CMP is 156.26

We believe coordinated US-Japan currency intervention marks a turning point and are making a significant revision to our BoJ policy outlook. We had assumed the BoJ would limit itself to gradual rate hikes of once every six months to align with the dovish Takaichi administration, and that the terminal rate would remain below the neutral rate at 1.5%. However, we now believe the coordinated intervention has effectively freed the BoJ from the constraints imposed by the administration, enabling it to pursue a more aggressive rate hike path. Accordingly, we are bringing forward our next rate hike forecast from December to September, and we expect the BoJ to continue hiking in Dec’26, June’27, and December’27, with the policy rate reaching 2% by the end of next year. The risk of more aggressive hikes remains, depending on Fed policy. Our new main scenario (60% probability) assumes four rate hikes, in September 2026, Dec’26, June’27 & Dec’27. In what we see as the more likely risk scenario A (25% probability), we assume rate hikes in September 2026, December 2026, March 2027, and June 2027 in view of the increased risk of higher-than-expected inflation as a result of yen depreciation. Together with our main scenario, this gives a probability of 85% for a rate hike in September 2026. In our less likely risk scenario B (15% probability), we assume only two rate hikes in October 2026 and Mar’27. Going forward, the primary focus will be on how quickly the BoJ can proceed with rate hikes—without causing significant damage to the real economy or equity markets—in order to contain excessive yen depreciation and upside inflation risks. BOJ's outlook for next year is heavily dependent on Fed policy. Our view is that the Fed is likely to be on hold for a long time with the next rate action a cut than a hike, but should the Fed enter a rate hike cycle contrary to our forecasts the BoJ could be compelled to adopt a faster pace of hikes (e.g., once every three months) and the terminal rate could exceed 2%. To summarise, BOJ is likely to focus on JPY depreciation led inflation and respond hiking by 50 bps in REMCY26. Terminal rate now looks 2% rather than the previous 1.5% estimates. Takaichi administration & US treasury together will force BOJ to leave it’s dovish stance & focus on real interest rates which are deeply -ve.

The Japanese and U.S. authorities conducted a coordinated FX intervention on 31 July. Both governments have acknowledged that the intervention was carried out. While the amount of yen buying by the US may be limited, the signalling effect of this rare, coordinated intervention is significant. We see the recent joint action as showing strong commitment from both sides. The fact that the operation was coordinated suggests that extensive currency diplomacy took place beforehand. The shift to coordinated intervention with the United States raises expectations for a broader policy framework aimed at stabilizing the yen. This is in interest of US as a rapidly depreciating JPY was aiding Japanese exports, pulling JGB yields higher & pushing long end UST yields higher along with it. If MoF Japan had intervened on it's own, they will have to sell USTs further pushing UST yields higher. By coming to MoF's rescue, US treasury has defended not only long end UST yields but also ensured Japan does not indiscrimately sell USTs to support it's fx operations. A coordinated intervention effectively blurs the ceiling associated with unilateral currency intervention. In addition, Treasury Secretary Bessent has encouraged the use of the Foreign and International Monetary Authorities (FIMA) Repo Facility, while Finance Minister Katayama has also stated that Japan intends to make use of the facility. The degree to which both governments have presented a united front is notable, both in emphasizing the potential firepower behind Japan's yen-buying intervention and in limiting any adverse impact on the U.S. Treasury market. Considering this joint intervention, we believe stars are now aligned for BOJ to hike in Oct’26 and Mar’27. We believe Fed might be on hold for REMCY26 and hence we view JPY likely to test 155 now more than 160. Our bullish view on JPY needs to be validated by BOJ hiking in Oct. We now see test of 155 levels of JPY imminent and a breach below this level might accelerate inwards flows from life insurance and exporters. The stop to the above view is BOJ delaying hike beyond Oct or JPY breaching 160 on a weekly basis. Our CY26 end target for JPY is now 152. CMP is 157.76.

US Job gains slowed to 57k in June (Our estimate: 75k, Consensus: 113k), along with 74k of negative revisions to the prior two months. The deceleration was largely driven by negative payback after unsustainable strength in past months. Beyond the monthly noise, underlying employment growth remains solid. While the weaker US June NFP report (+57K vs. consensus +113K) led USD lower (at least initially), we believe it may still be a little early to call this the start of a USD downtrend. The forces that have combined to strengthen the Dollar over the last few months look increasingly likely to endure. We remain most bearish on JPY and then GBP. We remain neutral on EUR and bullish on CNH.

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.