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FX BANK FORECAST · COVERAGE
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Aggregated year-end forecasts, scenario shifts, and curated analyst notes from 30 institutional desks. No promotion.
FX BANK FORECAST · COVERAGE
Aggregated year-end forecasts, scenario shifts, and curated analyst notes from 30 institutional desks. No promotion.
The desk anticipates a bearish outlook for the USD following the Fed's policy update, which could catalyze further declines in the currency. Per the full note from MUFG EMEA, analysts Lee Hardman and James Roulston highlight that the market is bracing for a dovish shift from the Federal Reserve, potentially leading to a weaker dollar in the near term. This perspective is underscored by recent economic data indicating a slowdown in inflation, which may prompt the Fed to reconsider its tightening stance. With no high-impact events on the calendar in the next month, the focus will remain on the Fed's upcoming announcements and market reactions to them.
MUFG emphasizes that the outlook for the USD is precarious as the financial markets respond to ongoing political and economic influences at the start of Trump's second term. The anticipated Fed policy update may catalyze another decline in the dollar's value, particularly if dovish signals are perceived in the announcement.
The USD’s recent softening may reflect broader anxieties around fiscal policy and its implications on economic growth. If the Fed hints at a slower pace of rate hikes or even considers adjustments in response to evolving economic conditions, it risks further loss of confidence in the dollar, driving it to lower levels against major currencies.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
Market implications
A lower USD could enhance competitiveness for U.S. exports, but could also lead to inflationary pressures as imported goods become more expensive. This dual impact necessitates close monitoring of economic indicators post-Fed announcement to gauge the full ramifications on the dollar's trajectory.
Risks to this view
The primary risks to this outlook stem from geopolitical tensions and unexpected shifts in domestic economic performance. Additionally, a stronger-than-expected Fed signal could reverse current USD softness, complicating short positions across FX markets.
Welcome to the MUFG Global Markets FX Week Ahead podcast with Leigh Hardman, Senior Currency Analyst at MUFG. It's Friday, the 24th of January, 2025. And joining me to pose some questions on the financial market themes for the week ahead is James Roustan, FX Institutional Sales.
The following podcast is intended for professional investors and eligible counterparties only, and not for retail clients. Any content should not be regarded as an offer to conduct investment business or an investment recommendation, but for information purposes only. Okay, great.
So thank you very much for joining me Leigh. We are here to do the podcast, the weekly podcast. There's a couple of big key topics that we want to cover off today.
If it's okay, we just jump straight back in. Yeah, sounds good to me. Fantastic.
Okay. So first up is the FX markets have been impacted by Trump's first week, obviously big week in the US, but how has it sort of played out in the FX space? Yeah, we have seen some big moves, like you say, in Trump's first week with the dollar selling off really across the board.
To us, that kind of mainly reflects some kind of initial disappointments amongst market participants that Trump didn't raise tariffs immediately at the start of his second term. If we look at how the dollar's performed since the US election, we've already seen the dollar obviously strengthened quite significantly. We look at positioning there and leveraged funds have built up very big, long dollar positions to the highest level since all the way back in September 2018.
So this was obviously a very crowded trade and that even that kind of initial disappointment that tariffs are coming in more slowly, that has triggered a correction lower for the dollar. Having said that, though, there's still enough there from Trump indicating that he does plan to go ahead with tariff hikes going forward. He's ordered reviews into the trade practices of US trade partners, including Canada, Mexico and China.
And he has set a deadline for the 1st of April to provide an update on those trade practices and to provide recommendations. So to us, this is likely to provide the justification then for Trump to go ahead and put higher tariffs in place and other trade restrictions. So this kind of more gradual, I guess, phase in of tariffs, while it may initially kind of weigh on the dollar, we still think ultimately these tariff hikes are coming and that when they're put in place, it's ultimately going to be supportive for the dollar.
So for us, this is more of a kind of temporary setback for the dollar. And we're still expecting the dollar to be strong this year. Yeah, it's certainly been a busy week and that's all due to Trump.
So it's been it's been a good week. OK, so moving on, there was the Bank of Japan hiked their rates this week or earlier today. It's the third time in the current tightening cycle.
Do we expect the Japanese yen to strengthen as the Bank of Japan tightens its policy? Yeah, like you said, we have seen the BOJ follow through and deliver another rate hike today. The market reaction, though, has been somewhat muted.
Initially, we did see the yen dropping back towards the 155 level, but that does look like it's a good support level for the pair. Since then, it has bounced off of that level. So there has been relatively kind of limited follow through for yen strength after today's BOJ hike.
And we can see that as well against the other kind of non-dollar yen crosses, which have held up much better. So to us, this, I guess, reflects a number of factors. One, I think the BOJ was very keen this time around to telegraph the rate hike.
They obviously wanted to reduce the risk of a pickup in financial market volatility after the hike today. Obviously, they learned their lesson from what happened back in July of last year when we saw the very disruptive market impact from the second hike in the tightening cycle. So I think they'll be reasonably pleased that they've kind of got away with hiking rates today.
And the communication as well hasn't forced a sharper strengthening of the yen. I'd still say, though, that if you look at the updated communication from the BOJ, I think the direction of travel is still very clear, is that they're still indicating that there's still room there for rates to keep moving higher in Japan if the economy and inflation continues to move in line with their outlook going forward. The one area, though, which is still uncertain is the timing of the next rate hike.
I think the BOJ has been deliberately very vague about how quickly they'll hike rates again. So for us, we still think they're probably comfortable enough to kind of stick to the current pace of, say, one rate hike every six months. So to us, that would suggest that the earliest point, the next rate hike would be delivered in July.
I think for now, at least, that's probably not enough really for the market to be encouraged to kind of push the yen much stronger from here. We obviously know as well that the Fed have indicated that they're going to be slower about cutting rates as well this year. So I think that both of those factors are helping to kind of keep dollar yen at higher levels.
But our view still is that over the kind of next six to 12 months that the risks are more tilted to the downside for dollar yen. Perfect. OK, so those are the two things that have sort of moved us this week.
We've got a busy week ahead of us next week. Again, we've got the Fed and the ECB with central bank updates. Are we likely to see the FX impact there as well, if that's OK?
Yeah, like to us, this is one of the, I guess, interesting stories at the start of the year for FX markets is that we do see monetary policy starting to diverge more between the Fed and other major central banks like the ECB, Bank of England and the PBOC over in China. Like I said before, I think the Fed have been very clear now that they plan to be more cautious over delivering further rate cuts. They want to take more time to see how the US economy is evolving at the start of this year and to see as well more details of Trump's initial policy plans before they're willing to cut rates further.
So to us, this suggests that the Fed's likely to keep rates on hold at least, I think, until, say, the second quarter of this year. You can't completely rule out the possibility that they could go at the following meeting in March. But at the moment, I think with the US employment picking up since the US election, if that continues at the start of this year, it would be more difficult for the Fed to cut rates again at the March meeting.
So with the Fed there potentially on hold for longer, we think that's a supportive factor for a stronger dollar at the start of this year, especially when you look at what other major central banks like the ECB, Bank of England, PBOC are likely to do. We still feel much more confident that they can continue to cut rates going forward. Even this week, we've had a number of comments from ECB officials, and I think the message is very clear, is that they're still comfortable with market pricing for 25 basis point cuts at next week's meeting and the following meeting.
So we're expecting the ECB to bring rates all the way down to 2% by the middle of this year. So with rates coming down more quickly outside of the US, it's hard to really argue in favor of a more sustained rebound for the euro against the dollar in the current environment. Perfect.
So we've got a busy week to look forward to as well next week. Fantastic. Thank you very much.
Brilliantly. That's been great. I hope you've all enjoyed.
Have a good weekend. Thanks for listening to the UFG Sales Rep for more information. Come back next week for more insights from the Global Markets Research Team.
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