US

USD index (DXY) rebounds slightly after hitting a four-year low yesterday. President Donald Trump said he’s not concerned about the currency’s drop, adding “The dollar’s doing great.” The comments are not surprising, as a weaker dollar fits squarely with the Trump administration’s drive to revitalize American manufacturing activity – one of the many versions of a so called ‘Mar-a-Lago Accord’ (we discussed that topic in our April 2025 quarterly report here).

USD has firmly undershot the level implied by rate differentials. However, structural drags on USD - fading confidence in US trade and security policy, politicization of the Fed, and worsening US fiscal credibility – can continue to outweigh the more neutral cyclical USD backdrop and pull USD lower, like in Q2 last year. Moreover, risk of additional intervention to weaken USD/JPY can spill over into broader USD weakness against other major currencies.

FOMC policy rate decision is today (7:00pm London, 2:00pm New York). 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.

CANADA

USD/CAD sliced through key support at 1.3600 and closing in on its June 2025 low at 1.3540. The Bank of Canada (BOC) policy decision and January Monetary Policy Report are due today (2:45pm London, 9:45am New York). The BOC is widely expected to keep the policy rate unchanged at 2.25% for second straight 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 stress again that “uncertainty remains elevated,” implying it’s in no rush to start raising rate. The latest 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 about 50% odds of a 25bps rate increase to 2.50% over the next twelve months.

We see room for the market to push out expectations for a BOC rate hike which is a modest headwind for CAD. 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.

EUROZONE

EUR/USD vaulted briefly above 1.2000 for the first time since June 2021, prompting some push back from ECB officials. Austrian central bank governor Martin Kocher said “If the euro appreciates further and further, at some stage this might create of course a certain necessity to react in terms of monetary policy…But not because of the exchange rate itself, but because the exchange rate translates into less inflation, and then this is of course a monetary policy issue.”

ECB Governing Council member Francois Villeroy de Galhau echoed Kocher’s comments stressing that “We are closely monitoring this appreciation of the euro and its possible consequences in terms of lower inflation…This is one of the factors that will guide our monetary policy and our decisions on interest rates over the coming months.”

EUR/USD is overvalued and trading above our long-term equilibrium estimate of around 1.1100. Historically, 10% to 15% overshoot of equilibrium is not unusual, which would suggest EUR/USD could be stretched between 1.2200 and 1.2600.

AUSTRALIA

AUD/USD surged briefly above 0.7000 for the first time since February 2023. Australia’s December CPI inflation ran hot. Headline CPI rose to 3.8% y/y (consensus: 3.6%) vs. 3.4% in November driven by Housing, Food and non-alcoholic beverages, and Recreation and culture. The policy-relevant trimmed mean CPI matched consensus at 3.3% y/y vs. 3.2% in November but was above the RBA’s 3.2% December projection.

The quarterly trimmed mean CPI was higher at 3.4% y/y in Q4 vs. 3.0% in Q3, the highest since Q3 2024, and argues for a 25bps RBA rate hike to 3.85% at the February 3 meeting. RBA hike odds for February rose to 70% from 60% ahead of the CPI data.

JAPAN

USD/JPY is trading a little bit above yesterday’s three-month low near 152.10. In our view, USD/JPY has room to converge with US-Japan rate differentials and trade closer to 140.00. The minutes of the Bank of Japan (BOJ) December meeting are outdated. At that meeting, the BOJ unanimously voted to raise the policy rate 25bps to 0.75% (widely expected) and stuck to its tightening bias.

However, the minutes suggest officials were increasingly concerned over the weakening yen. “Some members” noted that “although addressing developments in foreign exchange markets is not itself the purpose of monetary policy, in deciding whether to raise the policy interest rate, the Bank should give consideration to the impact of the yen's depreciation on inflation rates, and in some cases, on underlying inflation.

BRAZIL

Brazil’s central bank (BCB) policy decision is today (9:30pm London, 4:30pm New York). 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.