US
USD firmed today, largely reflecting JPY weakness. Japan Prime Minister Sanae Takaichi’s expansive fiscal agenda is an ongoing drag for JPY. Polls suggests Takaichi is headed for a landslide victory in Sunday’s general election.
The USD index (DXY) has retraced 50% of its January slump, underpinned in part by the FOMC’s less-dovish hold last week. DXY has room to claw back recent losses because the Fed is in no rush to resume easing and could cut rates less than is currently priced in (50bps by year-end). However, we don’t expect DXY to break above the range that’s been in place since June 2025. Other major central banks are done easing and USD faces important structural drags.
Congress is on the cusp of ending the partial government shutdown in the next 24 hours. Still, the Bureau of Labor Statistics (BLS) confirmed it will not release today’s December JOLTS data and Friday’s January jobs report. The BLS said “the release will be rescheduled upon the resumption of government funding.” Fed speakers today include: Richmond Fed President Tom Barkin (2027 FOMC voter), and Fed Vice Chair for Supervision Michelle Bowman.
The unexpected expansion in US manufacturing activity in January validates the case that Fed policy is in a good place. The ISM manufacturing index surged to 52.6, the highest since August 2022 (consensus: 48.5, prior: 47.9) and details were encouraging:
(i) New orders-to-inventories increased to 1.2, the highest since July 2021, indicating that firms may need to ramp up production as demand exceeds supply.
(ii) The employment index improved more than expected to a one-year high at 48.1 (consensus: 46.0) vs. 44.8 in December, underscoring the Fed’s reduced concerns about downside risk to employment.
(iii) Prices Paid index increased less than expected to 59.0 (consensus: 59.3) vs. 58.5 in December. The index remains well below last year’s high of 69.8 and is consistent with fading upside risk to inflation.
AUSTRALIA
AUD/USD rallied back above 0.7000. The RBA voted unanimously to raise the cash rate target by 25bps to 3.85%, the first increase since 2023. A hike was 70% priced-in by money markets ahead of the decision. The RBA justified the hike by noting that “inflation is likely to remain above target [2 to 3%] for some time.” Indeed, the RBA projects the policy-relevant trimmed mean CPI at 3.7% y/y by June and 3.2% y/y by December 2026 before easing back under 3% over 2027.
Moreover, the RBA signaled that more hikes are in the pipeline. The RBA highlights that “private demand is growing more quickly than expected, capacity pressures are greater than previously assessed and labour market conditions are a little tight.” However, RBA Governor Michele Bullock tempered rate hike expectations warning she does not know if policy is in a tightening cycle.
The swaps market implies an 80% probability of another 25bps rate hike in May and a total of 60bps of hikes in the next twelve months. We think the RBA can deliver on these rate hike bets because all the RBA’s internal models show a positive output gap consistent with tighter capacity constraints. Bottom line: diverging policy between the RBA and Fed supports the uptrend in AUD/USD.
INDIA
INR outperformed across the board and USD/INR plunged by over 1.5% after hitting a record high of 92.00 last week. The US and India reached a trade deal. The US will cut its levy on Indian goods to 18% from 50%, lower than most Asian peers. In return, India will reduce its tariffs and non-tariff barriers on the US to zero, agreed to buy $500bn of US goods, and halt crude purchases from Russia.
The trade deal eliminates an important drag on INR and leaves room for the Reserve Bank of India (RBI) to ease further. The RBI is expected to keep the policy rate unchanged at 5.25% on Friday after delivering a 25bps cut in December. We have a 25bps cut to 5.00% penciled-in. India core inflation is close to the lower end of the bank’s 2% to 6% target range and fiscal policy is modestly restrictive.
