US dollar rebounds – yield’s renewed influence on FX

Welcome to the MUFG Global Markets FX Week Ahead podcast with Derek Halperni, Head of Research, Global Markets EMEA and International Securities. It's Friday 15th May 2026 and joining Derek to pose some questions on the financial market themes for the week ahead is Julie Ellert, Head of Fraberlucks FX Sales. This material is only intended for professional investors in jurisdictions in which its use is permitted under applicable laws, rules and regulations.

It has been produced for information purposes only and should not be construed as investment research or advice. MUFG EMEA disclaimers and disclosures can be located on our website. Hello, Derek.

Hi, Julie. How are you? I'm good.

Thank you. Thanks for joining today. It's great to have you with us.

We have seen quite a lot of movement across FX markets this week, with some significant shifts in dollar dynamics, rate, political developments. I thought it would be useful to walk through a few key themes with you and get your perspectives on what's driving markets at the moment. So let's start with the US dollar.

It's having its best week since early March, despite having been relatively unresponsive to geopolitical tensions and higher energy prices until recently. Has something shifted in the FX dynamic? Yeah, Julie, definitely interesting week.

We're pretty close to the scale of strength we had in the first week of the conflict. We could actually finish with this being the biggest move stronger for the dollar since the conflict began. So in that sense, definitely notable.

The overall move is still not huge, 1.4-ish percent. But as you said, Julie, it is notable given the scale of the move. And is there a dynamic change taking place here?

I think obviously it's a little bit early to be 100% sure, but there's certainly some evidence. For a lot of the time since the conflict has begun, bar the initial period, there was always, I guess, more muted short-term rates moves in the US with the perception that the Fed would remain on hold for a period out, you know, certainly 12 months. That started to change.

So, you know, we now have pretty much close to a full hike priced by March of next year, a 50-50 probability of a hike by the end of this year. So rates are moving up. You know, despite all the geopolitics, you get back to the same old rule, which is, you know, the fundamentals matter, the economic backdrop matters.

And of course, this week we've had CPI, PPI and retail sales from the US all coming in on the stronger side. Crude oil prices have pushed higher, straight-up Hormuz remains closed. Therefore, on top of the actual data showing inflation picking up, you have the risks building in terms of the inflation outlook going forward.

So all of that together, and what we have is, I think, investors beginning to change their minds in relation to the Fed's reaction function. The other element in all of this, of course, is the fact that Powell's term as Fed Chair is finished. We'll have Kevin Warsh leading the way going forward from here.

And of course, there is an element of uncertainty in terms of how he will, I guess, communicate in the early stages of him being Fed Chair. I think it's clear what his medium to long-term goal is, and that is to bring rates down. He's a big believer in AI boosting productivity.

He said in a Wall Street Journal article that AI was very disinflationary. But can he come in at the very beginning, start pushing for rate cuts in an environment like I've just described? I think that's going to be difficult.

So I think there's a risk there that Kevin Warsh comes across maybe more balanced, or even, dare I say it, a little bit on the hawkish side. I think he doesn't want to differentiate himself too much from the rest of the FOMC in the very early stages of his chairmanship. And in that regard, given the landscape, he may well be more aligned with the broader FOMC thinking, which, by the way, we'll get more colour on next week.

We have the minutes from the April meeting released. And given the fact that there were three dissenters who were unhappy with the bias in the statement indicating the potential for further cuts, I would imagine the minutes are going to show a growing number of FOMC members becoming more concerned with the inflation backdrop. So I think all of this favours the potential for further moves higher in short-term rates in the US.

And what we're noticing in terms of FX correlations is that the VIX dollar correlation, you know, strong equity markets, low VIX has been a kind of a counter to dollar buying and has helped to weaken the dollar. That correlation is weakening, maybe because the corporate earnings cycle is now pretty much over. We've had a huge move in equities, 28% in the NASDAQ since the end of March.

Massive, massive move. And maybe that dynamic is going to start fading a little now that the corporate earnings for Q1 is over. And given what I'm talking about in terms of rates, we're actually starting now to see the US dollar rates correlation pick up.

And therefore, if rates continue to move a little bit higher in the US, that certainly favours further US dollar strength over the short term. Interesting. Moving to Japan, that better performance of the dollar has pushed dollar yen back above the level since around the early May, I believe, around the intervention period.

JDB's yields have also moved sharply, right, this week. What do you think? Will this increase concern in Tokyo?

And does JDB's selling signal further yen weakness ahead? Yeah, like they're in a difficult position. Fixed income globally is moving higher this week.

A notable move today in JDB is the 30-year yield up 14 basis points. What's interesting in terms of where Japan is a little bit different to the other major bond markets is 2s, 30s is steepening. And actually 2s, 30s in Japan is steepening quite considerably, up about 25 basis points in the month of May, so far.

And it is steeper since the conflict began. Whereas if you look at the US, the UK, even, certainly Germany, 2s, 30s has actually been flattening since the conflict began. So there's definitely a difference there.

And you have to say the fact that 2s, 30s is steepening so much in May, following the fact that the Bank of Japan didn't raise rates, as was originally expected, three to four weeks before that meeting. You know, I think there's definitely fears growing that the BOJ is being too cautious. It's behind the curve.

Inflation is rising. Therefore, real yields are falling. And that's not a conducive policy mix, given the inflation risks going forward.

So there's also, I think, concerns about fiscal policy. There's rumours about another supplementary budget. Finance Minister Katayama denied that today.

But I think ultimately, it all comes down to the BOJ and the fact that they're overly cautious. And it certainly raises the prospect, I think, that they'll raise rates at the next meeting. But from an FX perspective, you know, declining real yields, it's just not supportive for a lower dollar.

And given crude oil prices are rising, given global yields are rising, there was always a risk that the intervention that took place at the end of April, and again, on the 6th of May, there was always a risk that international developments would counter the success, the potential success of that. And if the current account data from the BOJ on reserves is correct, they spent about 10 trillion yen buying the yen, which would be the biggest episode of yen buying intervention since they started buying the yen and intervention in 2022. And when you look at the way the spot rate has moved, it will also be the least successful.

And that tells you the underlying dynamics for the yen are still pretty negative. Will they come in again, Julie? I think they nearly have to at this stage.

But if crude oil continues to move higher, if we don't have a resolution in the Middle East, if global yields rise further, the fundamental backdrop is just not in favour of yen strength. Thanks, Derek. I cannot let you go without maybe turning to the UK right here once again, seeing a backdrop of political uncertainty.

From your perspective, is it simply a case of selling the pounds? Or are there any other factors at play in selling recent performance? Well, we did have GDP data this week, which was stronger than expected.

So there's maybe a bit more resilience in the economy than was originally expected, which should follow through into Q2 data as well, because the March GDP figure was stronger than expected. But yeah, you know, the 10-year gilt yield is up 18 basis points today, the 30-year is up 20 basis points. So really, gilt's getting hammered this week.

And yeah, it's politics. It's incredible to think that we're on our seventh or eighth Prime Minister, since maybe the next Prime Minister will be the seventh or eighth since the Brexit referendum in 2016. So, you know, that kind of political uncertainty is still with us.

And of course, if Andy Burnham wins this by-election, it's going to go for in Makerfield, in Wigan, if he wins that. And by the way, it is an if, he should win it, but reformer really have got positive momentum in the constituencies around there. So if he wins that by-election, he does become Prime Minister, I think.

And then it's about, you know, how left will his policies be? And, you know, his past speeches, and he's made very clear that he is in favour of more borrowing for public investment. He's also in favour of wealth taxes, property taxes, higher income taxation increases.

So all of that certainly is a concern for the gilt markets. And I think as long as this uncertainty is with us, you know, gilts will remain vulnerable. I think the interesting thing today, and even this week, okay, the pound is underperforming, but it's not massively underperforming.

It's not the worst G10 currency, I think Swedish krona is. Today, euro sterling is close to unchanged. So it's mostly against the dollar and the dollar is strengthening against all currencies.

So the pound isn't really suffering significantly from us. But I think if we get more moves like we've had today, next week, I would imagine that would change. And it would certainly start to hit broader investor confidence.

And I would still say the risks are skewed to the downside, despite the fact reasonably resilient this week. Thank you, Derek, for the insight and this discussion today. Okay, great.

Thanks, Julie. And look forward to speaking again soon. Definitely, definitely.

There is a number of moving part across FX at the moment. So it will be important to stay agile in the coming days. We'll continue to monitor this development with you.

And of course, we're always happy to follow up on any of these themes offline. So thanks again for your time today. Thanks again, Julie.

Cheers. podcast, rate, review and subscribe. Contact your MUFG sales rep for more information. Come back next week for more insights from the global markets research team.