USD remains on softer footing ahead of FOMC meeting

USD: Fed is expected to deliver hawkish rate cut

The US dollar has continued to trade at weaker levels after recording two consecutive weeks of losses ahead of this week’s FOMC meeting. The dollar index has fallen from a high of 100.40 on 21st November to just below the 99.000-level. The modest weakening of the US dollar in recent weeks has been driven by a dovish repricing of Fed rate expectations, with the U.S. rates market now almost fully pricing in a third consecutive rate cut this week. There has been no strong pushback from Fed officials against rate-cut expectations since New York Fed President Williams stated on 21st November that he still “sees room for a further adjustment in the near term to the target range for the federal funds rate to move the stance of policy closer to the range of neutral.” His comments sent a strong signal that the Fed leadership remains inclined to deliver one final rate cut this year, encouraged by signs of a loosening labour market. However, the FOMC appears increasingly divided over the need for further easing. After Fed Governor Jeffrey Schmid voted to hold rates steady at the October meeting, it would not be surprising to see more dissents next week. Several officials, including Chicago Fed President Goolsbee, Boston Fed President Collins and St. Louis Fed President Musalem, have indicated they favour leaving rates unchanged. But we are not expecting significant changes to the FOMC’s updated projections for the economy or the policy rate. The median projections from September signalled the Fed planned to lower the policy rate to 3.4% in 2026 and 3.1% in 3.1%.

To push through a rate cut, Fed leadership may need to pair it with more hawkish guidance. We expect the updated communication to signal that the pace of rate cuts will likely slow next year, while emphasizing that the path remains highly data-dependent. A rate hike at the January FOMC meeting is already seen as unlikely by the U.S. rates market, and current pricing suggests roughly a 50:50 probability of another cut by March. By the January meeting, the Fed will have greater clarity on labour market conditions after the release of the November and December nonfarm payroll reports. More hawkish guidance next week could provide support for the US dollar and further delay expectations for another cut early next year. U.S. growth is expected to strengthen in the first half of next year, reflecting a rebound from the recent government shutdown and the impact of tax cuts included in the “One Big Beautiful Bill.” These factors could discourage additional rate cuts if they spill over into stronger labour market conditions.

RECORD CHINA TRADE SURPLUS TO ENCOURAGE STRONGER CNY

Source: Bloomberg, Macrobond & MUFG GMR

CNY/JPY: Diverging paths for CNY & JPY backed by record trade surplus

The yen has remained relatively stable during the Asian trading session with USD/JPY trading close to the 155.00-level. The stability of the yen has been supported by comments from Finance Minister Katayama who stated the government will take appropriate action to address excessive volatility or disorderly moves in the foreign exchange market, including those driven by speculation, in line with the principles outlined in the Japan-US joint FX statement issued in September. She told parliament she was deeply concerned about recent FX moves describing them as one-sided and rapid. While the comments do not represent a step up in verbal intervention, they continue to highlight a high state of alert.

The probability of direct intervention to support the yen would increase further if it continues to weaken after the upcoming Fed and BoJ policy meetings which are expected to narrow yield differentials in favour of the yen. The bigger than initially reported contraction in Japanese GDP of -2.3% annualized in Q3 is unlikely to derail the BoJ’s pans to resume rate hikes this month. Governor Ueda has already stated that the downturn is viewed as due to temporary factors and does not alter the BoJ’s view for Japan’s economy that it still recovering. The government’s bigger supplementary budget will also provide support for growth. The 10-year JGB yield has continued to move sharply higher at the start of this week moving closer to 2.00% extending its rise to around 30bps over the past month reflecting ongoing fiscal concerns and BoJ rate hike expectations.

In contrast to the recent underperformance of the yen, the Chinese renminbi has been strengthening against the US dollar. USD/CNY hit a fresh low last week at 7.0617 encouraged by Chinese policymakers setting the daily fix lower. The price action indicates that Chinese policymakers are becoming more comfortable to allow the renminbi to strengthen now that downside risks to growth from trade disruption have eased supported by the 12-month extension of the China-US trade truce, and reduction in tariffs applied to Chinese imports. The latest trade data released from China overnight revealed that export growth picked up to an annual rate of 5.9%Y/Y in November. Exports to the US contracted by -28.5% but was offset by stronger growth elsewhere including to the EU (+14.9%) and Asean countries (+8.4%). It has helped to lift the China’s trade surplus to fresh record high of USD1.18 trillion over the past year. The record trade surplus continues to indicate that the renminbi remains undervalued and China will come under building external pressure to allow their currency to strengthen in the year ahead.      

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com