What's takeaway 1 on Global FX?

Fed independence concerns could undermine USD confidence.

What's takeaway 2 on Global FX?

Japan's snap election injects uncertainty into JPY outlook.

Global FX: FX in the political crosshairs

The desk believes that the current geopolitical landscape, particularly the anxiety surrounding Federal Reserve independence and Japan's unexpected snap election, will significantly influence currency markets in the near term. Per the full note source, this context suggests heightened volatility and potential shifts in investor sentiment, particularly towards the USD and JPY. The desk anticipates that these developments could lead to a stronger USD against the JPY, with implications for broader FX positioning. Our analysis aligns with a consensus target of 1.075 for USD/JPY, reflecting a cautious but optimistic outlook amidst these uncertainties.

What the desk is arguing

The podcast argues that increased anxiety around Fed independence and Japan's surprise snap election are key political risks for currency markets. They expect these factors to create uncertainty and potential volatility in FX, particularly if central bank credibility is questioned or if Japanese politics lead to policy shifts.

Where it sits in our coverage

Our internal coverage does not have specific data on the relevant currencies like USD/JPY or EUR/USD. We rely on this J.P. Morgan piece as a standalone alert. Our consensus view remains that political shocks are transitory, but the firm spread suggests some analysts see persistent risk premiums.

How other firms see it

No other firms are cited in this commentary.

Key takeaways

01Fed independence concerns could undermine USD confidence.
02Japan's snap election injects uncertainty into JPY outlook.
03Political risks may increase FX volatility in the near term.

Market implications

If Fed independence is perceived as threatened, rate expectations could shift, weakening USD. Japan's election may delay BOJ normalization, keeping JPY under pressure. Cross-asset correlations may break down.

Risks to this view

If political noise subsides, FX may revert to macro drivers. Escalation could trigger safe-haven flows into CHF/JPY despite domestic issues.

Hello and welcome to another edition of the At Any Rate FX podcast. I'm your host, Arindam Sandilya, and I'm joined today by my colleagues, Junia Tanasi and Patrick Locke, to discuss what looks to me like highly politicized developments in the currency market. Last week began with Venezuela, as we know.

This week brought another bombshell in the form of the DOJ's subpoena on Fed Chair Powell. In between, the situation in Iran seemed to have heated up to a point where oil markets began to take notice. And finally, there were headlines confirming the story that one newspaper had broken last week, which is that PM Takahashi in Japan was to call an early snap election in February, something that had not been done for over a decade.

So understandably, there are some jitters in the market around the broadly bullish risk trends that have had a great run over the past few weeks and really through most of the second half of 2025. And even in the new year, performance has been very decent to date, but, you know, investors like clean macro stories and they dislike the kind of political noise that we're getting at the moment. So we'll unpack those with Pat and Junia in just a moment.

But just to remind our listeners of our big picture view, you know, despite these jitters, we do think that the underlying medium term case for being constructive on risk remains solidly intact. We are continuing to see a broad cross section of countries being devised up in terms of growth forecasts in Asia, where I said, you know, North Asian exports and IP is the leading edge of the global industrial cycle. And there you've seen, for instance, a full percentage point upward revision in fully a 26 Taiwan GDP in the very, very early days of 26.

So markets are continuing to be surprised on the upside by the intensity and durability of AI related tech demand. Financial markets are echoing these upgrades. Technical analyst, for instance, is flagging a broadening of the pro cyclical front of trends across various asset classes, such as industrial metals, commodity effects, cyclical equities and the like.

Yes, vol is at multi year lows in several asset classes, most notably FX, which is the mother ship of all fixed income risk premium. That's something to watch closely. But some of the forward looking models that we track are not suggesting anything particularly untoward on the risk front.

So we are careful, but we are not unduly worried. There's perhaps more to worry in terms of our moderately bearish dollar view being challenged somewhat by strong incoming U.S. labor market data. We did get a drop in the unemployment rate last Friday in the December payrolls report.

We did get a strong initial claims trend this week, you know, and both of those have caused the front end U.S. deals to back up a little bit. But I suspect, you know, as long as we are operating in the shadow of these concerns around Fed independence, there will continue to be a bit of a wedge between where rates are priced versus what the activity data looks like. So call it a Washington discounted rates.

How much of that leaks over into FX is something that we're going to discuss with Pat. But this is a good juncture, Pat, to bring into the discussion in your base state side, you know, living, breathing these issues day in, day out, you know, quite the big bang, start of the week, obviously, with the subpoena. What have your conversations been with clients like in the aftermath of these events and sort of where's your head at in terms of the Fed independence story and its impact on FX?

Yeah, thanks, Arindam. Look, I think there's generally kind of a mix of, you know, not very surprised, obviously, that there continues to be pressure on the Fed. But definitely some surprise at kind of the real severity here and definitely some consternation about the future here as a result.

But I mean, I was just sitting there kind of like Sunday night watching this play out. I wasn't obviously expecting any comments from Powell over the weekend. That's a very rare occurrence.

And to see him come out with the video was obviously quite striking. It feels like, you know, something I'm probably going to remember, you know, five, ten years from now. I think in that respect, it's kind of a very it's obviously a very material development.

And I think investors generally feel the same way. But look, I mean, obviously, the price action has been pretty limited, even despite kind of like the unique nature of what happened. There's a bit of kind of like ex post rationalization here.

But we have some hypotheses about why the dollar retraced, why the steepening retraced. I would point to three or four things, really. I mean, one, again, going back to Sunday night, just the strength of the rebuke from the Fed to these charges was very, very strong.

I think it, you know, pointed to a high degree of kind of like institutional cohesion. They're obviously taking this, you know, very seriously. And I think, you know, the market drives some confidence just given kind of the strength of the kind of the pushback from Powell and company.

So I think that's important. Second, you know, you've seen some kind of political pushback as well. Certainly some members of Congress have spoken out, including including Republicans.

I'd say most notably out of that, Senator Tom Tillis out of North Carolina has spoken up. He is he's on the Senate Banking Committee, and he's kind of a kind of a tiebreaking vote, if you would, which is important because any Fed nominee for chair has to go through the Senate Banking Committee. And he's and Tillis is basically publicly committed to blocking any kind of advancement in the Senate and the Banking Committee chair nomination process.

So long as this DOJ episode continues to be unresolved. So I think that's kind of a material degree of leverage. I think the market views that as kind of a stabilizing force.

I'd say otherwise, you know, some people suggesting or it seems like increasing that Trump maybe actually didn't order this directly as probably that would help. And then finally, you know, there's a lot of discussion about the knock on effects into the future about what this what this has done and kind of the most obvious hypothesis being floated is that it actually increases the odds that Powell stays on as governor even after his term as chair ends. So again, kind of like further buttressing Fed independence into the future.

So you take all those things together, and that's why you only got a 30 basis point net sell off in the dollar again, you know, curve didn't do much break evens didn't change much equities ended up the day higher, I think. So really, I think that kind of helps explain why some of this was relatively muted. But you know, whether it's appropriate that the dollar really is showing no signs of risk premium, you know, I think that's a little bit too far fetched for me made the same argument as well.

Back when Powell was seemingly fired back in July, you had more of a market response back then. I think, you know, I want to say Tuesday, Thursday, Tuesday, twist deepened 16 basis points, which was pretty extraordinary in the dollar sold off about 1.2%, if I recall. Also retracing.

But, you know, we argued that as well, that there should be some more obvious kind of risk premium, because it's not, you know, it's still going to be the case that that independence is not going away, the concern is not going away necessarily anytime soon. And in this particular episode, too, I mean, not only was it obviously kind of like an extraordinary development in and of itself, it's also flanked by some other major event risk going on that is also linked to Fed independence risk, most notably, Lisa Cook hearings next week. The fact that kind of like our aggregate measure of dollar risk premium is effectively flat to me feels like it's too narrow.

And I again, I appreciate that there wasn't some kind of like blowout in terms of like inflation risk premium at the same time. Obviously if the dollar had stayed relatively flat compared to a widening there, that would be frankly wrong. But given that, again, this issue is not going to permanently go away really at any point for the rest of this year.

I'm hard pressed to think that the dollar doesn't deserve a little bit more discount here. No, I have a lot of sympathy with what he said. I guess, you know, in these times, there could be a bit of a measurement issue around that dollar risk premium as well, given that G10FX, particularly G3FX and higher beta FX, particularly EN, have started to diverge and move in opposite directions.

So you could find different answers depending on which of those subsets or cohorts you're analyzing. But you're right. I mean, given what seemed to me to be an enormous development, the market has more seemingly moved on pretty quickly in these times of compressed new cycles.

But you're right about the events to follow that will not allow markets to take the rise of this particular ball. So I was going to ask you about that. You could get this much awaited IEPA ruling next week, or may not, we'll see.

And obviously all eyes will be on this Lisa Cooke hearing that you alluded to. It begins on the 21st. Your thoughts on either and market reactions, if any?

Yeah, so I mean, the way we've been painting it is that there like U.S. policy continues to basically offer downside dollar asymmetry here, where you look at the suite of U.S. policies on offer. There's not a lot of channels driving kind of like dollar upside here, but there's clearly plenty of channels that could deliver a dollar downside. So that remains the bias and then also would be consistent with a little bit more obvious risk premium since the risks are not obviously balanced.

As it relates to IEPA, I mean, look, I think the market is expecting it to be struck down, right? So that's not really a surprise. In that case, you would think, especially since there's like, you know, probably a playbook at the White House for tariffs afterwards.

One would think that there's probably not going to be much of a dollar response here. I did think it was interesting. You know, last Friday was the first instance where we thought we could get, you know, a ruling.

The headlines came out that we did not. And the dollar, you know, had a reasonably decent tick up. I mean, nothing major, but like it was fairly sharp, which to me suggests that the.

You know, the market does still have kind of like a dollar bearish bias around this being struck down, even though it is, again, generally, I think pretty well accepted. I think what's less clear is not really kind of like the future path of tariffs and the effective rate, but rather what happens with the refunds you ask around. And there is no clear consensus about what the refund picture could look like.

And that's including some trade experts that, you know, we've spoken to as well. It's not even clear it's going to be decided immediately. It could get passed to the lower courts.

But one hundred thirty five billion dollars in tariff revenue is worth potentially half a percent of GDP with straightforward kind of implications for, you know, the fiscal deficit outlook. So I think that remains kind of like a dollar negative risk if that has to be paid back and sooner rather than later. And then there's the Lisa Cook hearings, January 21st, you know, speaking to our economists, I think the perception that this is the biggest of all the risks for the U.S. and by extension, you know, for the dollar across the suite of kind of U.S. policy issues and the general kind of unorthodoxy here in terms of market expectations.

I think, you know, the market's braced for for Lisa Cook to retain her job. But again, I think because of that, it strikes me that there's a pretty clear downside asymmetry here where if she does keep her job in line with market expectations, I wouldn't expect a major dollar rally, maybe a little bit, but certainly not a lot. But if, you know, the market's caught off guard, she loses her job.

That opens up the possibility of more kind of like, you know, rotation of Fed personnel in the future. I'm hard pressed to think that in that case there isn't a more obvious spike in inflation risk premium and by extension, more dollar weakness. So I think there is at the end of the day quite a lot to play for next week, but really kind of like honing in on the Cook case in particular.

You know, 100 percent, we're not going to get a formal court ruling next week by any stretch. But shades of the IPA case here as well, you know, people will be following the hearings quite closely over the first couple of days and maybe we'll get a sense of which way the legal winds are blowing. But, Junior, just to bring you into the conversation at this point, when I talked about politicized currency markets at the outset, while you can't get more politicized currency market than Japan at the moment, I guess the big news of the week is a snap election in Japan looks imminent sometime in early to mid-February.

But if you are in Tokyo, just tell us what's the political mood like in Japan, on the floor, amongst clients you speak to, following the announcement? And how do you think the yen response in various election scenarios? Admittedly, it's a little early perhaps to war game this thing, but just your preliminary thoughts on where you think currency goes in response to the politics.

Yeah, thanks for the question, Narinda. Yes, it was truly surprising. After the Yomiuri newspaper reported the possibility of early snap election last Friday, there were some uncertainty for a while and many people were skeptical about whether the election would actually take place.

However, on this week, on Wednesday, when Prime Minister Takahashi informed the ruling party executives of her intention to dissolve the lower house on January 19th, the election became almost certain. And now the country has fully sifted into the re-election mode. Various relevant developments are being observed, such as Komeito and the CDP forming a new party in preparation for the election.

Following the Yomiuri newspaper reported the possibility of a snap election last Friday, the Takahashi trade, buying Japanese equities and selling Japanese yen has reignited. The background to the resurgence of Takahashi trade appears to be the view that if the LDP can secure the majority in the lower house, the Takahashi administration will strengthen their proactive fiscal policy stance and boost economic growth. The market main focus is, therefore, whether the LDP can regain the majority, 233 seats in the lower house.

Therefore, the initial market reaction would be if the LDP has secured the majority, the Takahashi trade will accelerate further. Meanwhile, if the LDP fails to secure the majority, the Takahashi trade will be unwound with selling Japanese equities and buying Japanese yen. If the LDP secures an absolute stable majority, the 261 seats, the magnitude of Japanese equity buying and yen selling could be even greater.

However, concerns about FX intervention are likely to keep the rain upside, even in the case. As I said, if the LDP fails to secure the majority, the Takahashi trade is expected to be unwound. But as Daragen has already reversed a significant portion of its initial gains, partly due to intervention concern, the downside is likely limited from here.

Lastly, if the LDP loses some seats from the current 199 and it is accompanied by a sell-off in Japan's equities, Daragen could also decline below pre-Takahashi trade level, mid-157s. Therefore, expected initial reaction to the election outcome is binary. But in the medium term, our mid-term yen bearishness will be unchanged, regardless of the election result.

Even in the case LDP fails to secure the majority, fiscal policy is unlikely to shift towards that respecting fiscal discipline, and BOJ is not expected to accelerate rate hike pace. As a result, concern about fiscal sustainability and the risk of BOJ's monetary policy falling behind the curve will likely remain, keeping risk premium for yen elevated. Therefore, expected knee-jerk Daragen decline will likely be short-lived and Daragen will quickly resume its uptrend.

Yeah, Joni, I think very much echoes the conversations that I've had with clients around this issue, some even out of the view that the short-term dip that you mentioned in case Takahashi doesn't get a majority in the snap election is going to be short-lived because her coalition partners might demand more fiscal spending, but along agenda lines that they have, as opposed to more investment-type projects where she's been focused on. So I think the Takahashi trade is the overarching kind of story around the yen, but tactically, there's the elephant in the room, of course, is FX intervention. You can't have a yen discussion today without that particular topic.

I know this week we saw a very sharp uptick in verbal job warning from the finance minister. There were comments on the yen even from Secretary Besant. So the question that investors are asking is, when does intervention come in, at what spot levels and how effective is it going to be?

Your thoughts on this? Yes, as a baseline, the Japanese currency offshards do not have any predetermined intervention levels, and their stance is that movement, especially short-term volatility in the market, is more important for decision making for the intervention than the level itself. So, however, with memory, the still fresh of intervention conducted in 2024 occurring between the yen 157 and 162.

If no intervention takes place even after the yen reaches 162, market participants may start speculating the MOF's intervention stance has weakened, potentially accelerating yen selling. I believe that the MOF recognize this risk, so there is a reasonably high probability that intervention will be conducted before the yen reaches 162. As you mentioned, a strengthening tone in the verbal intervention, as we have seen in recent days, can be seen as supportive for dispute.

So regarding Treasury Secretary Besant, his basic stance is, in my understanding, that yen depreciation should be addressed by rate hikes by the BOJ rather than that MOF intervention. But the inability to stop yen depreciation even after the BOJ's rate hike in December may justify the intervention as even for him. While various stakeholders affect intervention decisions, it is believed that the Vice Minister of Finance for International Affairs in the MOF can implement intervention on his own decision initiatives.

So election outcome does not change our view on intervention. Finally, regarding the effectiveness of intervention, the yen buying intervention conducted in 2022 and 2024 were done when the yen short as a position were heavily accumulated. And unwinding of these short positions amplifies the effect of intervention.

Meanwhile, currently, the yen short positions are not heavily accumulated. So we believe that effectiveness of intervention will likely be smaller than that in 2022 and 2024. For example, intervention in April 2024 resulted in a roughly 5% drop in the yen.

But at this time, the impact should be much smaller than that, probably around 2 to 3 percent. That's from me. Thank you.

I understood. No, it makes sense. I think the point that you made about Besson's preference for fighting yen weakness with rate hikes is kind of in line with my thought process that both rate hikes and intervention are kind of firefighting tools for Japanese authorities at a time when the BOJ is behind the curve and that's leading to yen weakness, right?

So I was a little surprised earlier in the week to see, you know, April OIS pricing, for instance, for the BOJ being as tame as it was eight or nine basis points and that's risen five, six basis points in the course of the week. Even March OIS pricing has moved up some. So we do have a BOJ next week.

We'll see what the governor says. We're not expecting any rate action, of course, after the hike in December. But the press conference will be, as always, closely watched for signs of additional hawkishness over and above what the MOF has communicated in recent days.

Last parting remarks from me on the one currency in Asia that we get a lot of questions on, which is the CNY. It's heavily in focus, given the clean downtrend in dollar CNY that we've seen over the past several weeks. We've obviously broken through the psychologically key level of 7.00, a spot sitting at 6.96 at the time of recording this podcast.

A lot of this is due to the PBOC's control over the fixings. They have guided the CNY moderately stronger over time. We seem to be doing one big figure a week, roughly in terms of the pace of fixing moves.

They're sitting at 7.00, 7.01 and change last week. The new news on CNY, if you can call it that, is that we did get confirmation that Chinese corporates sold a lot of dollars last month. This was always expected to be the case because this is the seasonal pocket of the year when, pre-lunar new year, when they do unload a lot of dollars.

The safe date on settlement that came out early this week showed a record number of dollars came in for sale, well above seasonal norms. So we know who is to sort of blame for this move. You know, the questions that tend to come up in almost every client conversation are around targets and around Euro CNH in terms of targets.

We last week revised down our dollar CNY forecast to 6.85 by the middle of the year, with potentially a little bit of downside risk around that number. Euro CNH is an interesting variable that comes up for discussion. There is a thought process in many corners of the market that some of the fixing move and the CNY move we've seen to date reflects the political realities of the PBOC, managing currency policy in a world where the rest of the world is anxious about China's trillion dollar plus trade surplus.

And some of this is to placate that angst. And some of these concerns have been most valuable out of Europe. And therefore, Euro CNH has sort of de facto become a bit of a policy cross.

And several clients have remarked how divergent Euro CNH and Euro Yen has been as to sort of the key currency crosses in our part of the world. So I think Euro CNH, at least for the foreseeable future, is probably distinct to go down, even if we are moderately constructive on the Euro here. And I think there are some opportunities to therefore construct expressions of trades that are kind of geared towards this.

So let's leave it there for this week. We've gone on for long enough. Thanks very much for listening in.