- Fed poised to stand pat. Powell risk talking tough.
- Bank of Canda and Riksbank seen sticking with on-hold bias.
- Australia December CPI to steer RBA February rate decision.
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USD fell against all major currencies last week despite solid US economic data and a modest upward adjustment to US rate expectations. USD weakness likely reflects increased FX hedging by foreign holders of US securities amid fading confidence in US trade and security policy. Possible coordinated intervention on Friday to curtail JPY weakness amplified the decline in USD.
We expect the dollar index (DXY) to hold above its July and September 2025 lows as the Fed shows no urgency to resume easing. However, structural drags on the dollar could dominate the more neutral cyclical backdrop and push USD lower, like in Q2 last year.
Coordinated Intervention?
USD/JPY plunged during Friday’s New York session, sliding from about 158.30 to a low near 155.70 in a move that bears the hallmark of official intervention. In fact, news emerged that the New York Fed conducted a survey (rate check), at the request of the US Treasury, asking market participants yen pricing.
US involvement is entirely plausible. Earlier in the week, Treasury Secretary Scott Bessent voiced concerns about the sell-off in Japanese government bonds, made worse by yen weakness, and its spillover into the US Treasury market. It remains unclear whether the FX market action was coordinated with the Bank of Japan.
We think USD/JPY has finally topped out, opening the path toward 140.00-145.00, the level implied by rate differentials. First, worries over Japan fiscal profligacy are overdone given that growth comfortably exceeds borrowing costs. Second, Japan’s mix of loose fiscal policy and tighter monetary policy is JPY positive.
Fed: Stand Pat, Talk Tough
FOMC policy rate decision is Wednesday. The FOMC is widely expected to keep the target range for the Fed funds rate unchanged at 3.50-3.75%. The press release is likely to stress again that inflation “remains somewhat elevated,” and “downside risks to employment rose in recent months.” We expect all but one FOMC member to back a hold, with Fed Governor Stephen Miran renewing his call for a 50bps cut. Risk is Fed Governors Christopher Waller and/or Michelle Bowman favor a 25bps cut.
Fed Chair Jay Powell will likely talk tough which can offer USD support. Leading indicators point to a resilient US growth outlook, weekly jobless claims continue to suggest there’s no layoff spiral underway, and PCE inflation is stalling above the Fed’s 2% target.
A Politicized Fed?
Investors’ concern over the politicization of the Fed were dialed back a notch. National Economic Council Director Kevin Hassett - a staunch loyalist who shares President Donald Trump’s unconventional monetary policy view - was sidelined for the Fed chair job. Moreover, the US Supreme Court hearing related to President Trump’s efforts to fire Fed Governor Lisa Cook signaled reluctance to side with the administration. A final court ruling is expected by July.
Nonetheless, threat to the Fed’s independence persist underscored by the recently issued grand jury subpoenas against the Fed and ongoing criticism of Fed policy. These actions threaten the Fed’s inflation-fighting credibility and can accelerate the dollar’s declining role as the primary reserve currency.
President Trump could announce his Fed chair pick this week. The remaining three Fed chair finalists may not be as overtly dovish as Hasset, but they still sit on the easier side of the policy spectrum. Rick Reider’s (fixed-income chief at BlackRock) probability to get the Fed chair job has surged to as much as 51% from a low of 4% earlier this year. Kevin Warsh’s (former Fed Governor) odds dropped to 29% from a high of 61% a week ago. Fed Governor Christopher Waller remains a distant third with 7% chance.
BOC & Riksbank on Ice
The Bank of Canada (BOC) policy decision and January Monetary Policy Report are due Wednesday. The BOC is widely expected to keep the policy rate unchanged at 2.25% for second consecutive meeting. The BOC is also poised to reiterate its on hold guidance that it “sees the current policy rate at about the right level to keep inflation close to 2%.”
The BOC will likely caution again that “uncertainty remains elevated,” implying it’s in no rush to start raising rate. Saturday’s threat by President Donald Trump to impose 100% tariffs on Canadian goods entering the US if it proceeds with a trade deal with China, underscores the BOC’s caution. The swaps curve price in 60% odds of a 25bps rate increase to 2.50% over the next twelve months.
We see room for the market to further push out expectations for a BOC rate hike, suggesting USD/CAD will likely stabilize around 1.3600. First, core inflation (average of trim and median CPI) cooled more than the BOC projected in December (BOC’s Q4 projection: 2.9% y/y). Second, the BOC’s Q4 Business Outlook Survey showed the share of firms planning to lay off staff in the next twelve months rose to its highest level since Q2 2016.
The Riksbank policy decision is Thursday. The Riksbank is widely expected to leave the policy rate unchanged at 1.75% for a third straight meeting and reiterate that “the policy rate is expected to remain at this level for some time to come.” The Riksbank pencils in the policy rate at 1.75% until Q4 2026, followed by a 25bps hike over the subsequent two years.
The swaps curve price-in 40% odds of a 25bps rate hike over the next twelve months and that’s unlikely to change much in the near term. USD/SEK is trading near a four-year low after slashing through important technical support at 9.0000. Next USD/SEK support is offered around 8.9000.
Eurozone GDP Check
EUR/USD surged to a multi-month high near 1.1834 on Friday and is now targeting its September 17, 2025 high at 1.1919. The swaps curve price-in steady ECB rates at 2.00% over the next twelve months and that’s unlikely to change much in the near term.
Eurozone Q4 GDP is due Friday. Real GDP is projected at 0.2% q/q vs. 0.3% in Q3 with a sharp contraction in Ireland’s GDP seen subtracting 0.1pts from Eurozone growth according to the ECB. More importantly, leading indicators (IFO, PMI) continue to point to a favourable Eurozone growth outlook. Bottom line: the ECB is in a good place to keep rates on hold for some time.
Australia CPI to Steer RBA
AUD/USD rallied last week to near 0.6900, highest level since October 2024, underpinned in part by a sharp upward adjustment to Australia rate expectations. Bets for a 25bps RBA rate hike to 3.85% at the next February 3 meeting more than doubled to 60% last week following Australia’s strong December jobs report.
Australia December CPI is due Tuesday. Headline CPI is expected at 3.6% y/y vs. 3.4% in November and the policy-relevant trimmed mean CPI is seen at 3.3% y/y vs. 3.2% in November. If trimmed mean inflation tracks above the RBA’s 3.2% y/y December projection, that could seal the deal for a February rate increase and support a firmer AUD. Next resistance levels for AUD/USD are offered at 0.6942 (September 30, 2024 high) and 0.7000.
EM Central Bank Watch
National Bank of Hungary policy rate decision is Tuesday. The bank is expected to keep rates steady at 6.50% for a 16th consecutive meeting. The risk is the bank lays the groundwork for rate cuts this year as inflation is converging towards the bank’s 3% target while parliamentary elections are scheduled for April 12. The swaps market price-in nearly 75bps of cuts over the next twelve months.
Chile’s central bank policy decision is Tuesday. The bank is expected to keep the policy rate on hold at 4.50% after delivering a 25bps cut at its last December 16 meeting. Inflation is tracking the bank’s December projection. The swaps market price-in a total of 25bps of cuts in the next 12 months and the policy rate to bottom at 4.25%. That’s seems about right. Chile’s central bank estimates the neutral policy rate to be between 3.75-4.75%, with the midpoint of this range at 4.25%.
Brazil’s central bank (BCB) policy decision is Wednesday. BCB is expected to keep the policy rate at 15.00% for a fifth consecutive meeting. The key issue is whether the BCB drops its hiking bias, clearing the way for rate cuts over the next few months. We expect that it will because inflation has steadied at the upper end of the bank’s 4.50%-1.50% tolerance band and the fiscal stance is projected to tighten slightly in 2026.
The swaps curve implies 250bps of BCB rate cuts to 12.50% in the next twelve months. The risk is BCB does not ease as much as is currently priced in given that the October 2026 general election skews fiscal policy toward near-term spending support.
South African Reserve Bank (SARB) policy decision is Thursday. SARB is expected to deliver a back-to-back 25bps policy rate cut to 6.50%. However, it’s a close call: 9 of the 20 analysts polled by Bloomberg see rates on hold. We think SARB can afford to pause easing because inflation is settling around the bank’s inflation target of 3% (with a +/-1% tolerance band). The swaps curve price in nearly 50bps of cuts in the next twelve months and the policy rate to bottom at 6.25%. SARB pencils in the policy rate to bottom lower at 6.00% in 2027.
Colombia’s central bank policy decision is Friday. The bank is expected to raise the policy rate 50bps to 9.75% after holding at 9.25% for the past five straight meetings. Domestic demand growth is strong and the convergence of inflation toward the 3% target is stalling. The swaps curve implies 250bps of rate increases over the next twelve months.
