Opinions

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.

There were two relatively big falls in USD/JPY on 23 January 2026, and Nikkei reported the possibility of a rate check by the NY Fed at the direction of the US Treasury. If this is true, market expectations for US-Japan joint intervention could rise. Then, efficacy of future actual intervention, if any, will likely be more significant. Historically, coordinated FX interventions among G7 economies have typically been implemented in response to emergency situations. For example, the most recent coordinated intervention occurred on 18 March 2011, following the Great East Japan Earthquake, in the form of coordinated USD-buying and JPY-selling intervention. If the current situation is indeed evolving toward US–Japan coordinated intervention, it would suggest that both the US Treasury and Japan’s MOF are taking recent movements in the exchange rate very seriously. As per our estimates, Friday’s market intervention was to the tune of $187 BN. Treasury Secretary Bessent had spoken to Japan’s finance minister Katayama this week about the selloff in Japanese debt, adding it had affected the Treasuries market. The Trump administration has previously signalled a desire to contain long-term US borrowing costs. Hence, we believe that a joint US Japan intervention to support JPY is now in action. This implies JPY is now unlikely to break July 2024’s high of 161.75. Hence it becomes now a sell on rise for USDJPY. But without actual hikes from BOJ, it might not meaningfully drift lower too, this giving a medium-term range of 152-160 till June’26.

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.