Muted FX market impact from pick-up in geopolitical risks

USD: Forced regime change in Venezuela has muted FX market impact

The US dollar is starting the new calendar year on a stronger footing with the dollar index on course to increase for the fourth consecutive trading day and hitting a high of 98.796 overnight. The main development over the weekend were the actions taken by the Trump administration to force regime change in Venezuela by forcibly removing President Nicolas Maduro. However, the initial market impact has been relatively muted. Market participants will be mainly watching the impact on the price of oil to assess the potential broader financial market impact, and spill-overs into the foreign exchange market. The price of Brent has dropped modestly overnight moving back closer to recent lows at around USD60/barrel perhaps reflecting relief some initial relief that supply is unlikely to be significantly disrupted in the near-term. Venezuela has become less important for global oil supply after decades of economic mismanagement. It is currently only the 18^th largest oil producer at around 1 million barrels/day which accounts for just 1% of global supply. It compares to production of around 3.5 million barrels day in the 1970’s. There is optimism though that Venezuela could become major producer again if regime change proves successful in unlocking untapped potential and helping to boost global oil supply. Venezuela still claims to hold the world’s largest proven oil reserves although much is extremely heavy making more costly to extract and process.

It remains to be seen how successful regime change will prove to be in Venezuela. Delcy Rodriguez, the acting president of Venezuela, extended “an invitation to the US government to work together on a cooperation agenda, aimed at shared development, within the framework of international law, and to strengthen lasting community coexistence”. It follows a warning from President Trump that “if she doesn’t do what’s right, she is going to pay a very big price, probably bigger than Maduro”. He wants “total access” to oil to rebuild the country. The pick-up in geopolitical risk has helped to support in the price of gold after the sharp correction lower at the end of last year. Overall, we are not expecting the developments in Venezuela to have significant implications for our FX outlook in 2026 consistent with the initial muted market impact.

USD/JPY VS. SLOPE OF JGB YIELD CURVE

Source: Bloomberg, Macrobond & MUFG GMR

JPY: Weak yen keeps BoJ rate hikes & Japanese fiscal risks in focus

The sell-off in the JGB market has restarted at the start of this week with the 10-year yield hitting a fresh high overnight at 2.13%. It has now risen by around 45-50bps over the last couple of months. The sharp ongoing sell-off continues to reflect concerns over fiscal risks in Japan under Prime Minister Takaichi, and the hawkish repricing of BoJ rate hike expectations. Over the same period the 2-year JGB yield has increased by around 25-30bps which is more closely linked to BoJ rate hike expectations. It has jumped higher by almost 10bps over the last couple of trading days as market participants move to price in more active tightening from the BoJ. The Japanese rate market is more fully pricing in two further 25bps hikes from the BoJ in 2026 with the next hike expected in June or July. The weak yen and loose fiscal policy will put more pressure on the BoJ to raise rates further this year.

The hawkish repricing of BoJ rate hike expectations was encouraged by comments from Governor Ueda overnight. He used his first public appearance this year to reiterate that “we will keep raising rates in line with the improvement in the economy and inflation” adding that “the appropriate adjustment of monetary easing will lead to the achievement of stable inflation target and longer-term economic growth”. He expects the “mechanism between moderate wage growth and inflation is likely to maintained”.

The weak yen will keep pressure on both the BoJ to hike rates sooner, and the government to consider intervening directly in the FX market to provide support for the yen. One positive for Japan has been that USD/JPY has been consolidating at higher levels between 155.00 and 158.00  over the last couple of months. The risk of intervention would step up if USD/JPY regains upward momentum and retests last year’s highs at 158.87. The sell-off at the long-end of the JGB curve also highlights that the government needs to take action to restore confidence in their commitment to  fiscal discipline which would help ease yen selling pressure as well.        

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com