USD vulnerable to further weakness at start of this year

EUR: Benefitting from its role as the anti-dollar as French political risks ease

The major foreign exchange rates have stabilized overnight following the heavy US dollar sell-off since the end of last week. Broad-based US dollar weakness has helped to lift EUR/USD back to within touching distance of the high from last year at 1.1919 from 17^th September. A break above that level would open the door for the pair to rise back above the 1.2000-level for the first time since the first half of 2021. The euro has mainly benefitted from its position as the most liquid alternative to the US dollar. Heightened US policy uncertainty at the start of this year is contributing to a loss of confidence in the US dollar (click here) in the near-term as evident by the recent divergence between yield spreads and US dollar performance. President Trump added to US policy uncertainty again overnight by threatening to hike tariffs on imports from South Korea on autos, lumber, pharmaceuticals products and “all other reciprocal tariffs”. The new higher tariff threat comes in response to South Korea’s slow implementation of the recent trade deal which had lowered tariffs to 15%. President Trump warned South Korea that it is “not living up to its Deal with the United States”. It quickly follows his threat to impose tariffs up to 100% on Canada if the government signs a trade deal with China. The South Korean won has weakened modestly overnight following President Trump’s latest tariff threat although is still around 2.5% higher against the US dollar than last weeks’ lows. The won has strengthened alongside the yen triggered by heightened speculation over imminent intervention. Market talk over potential coordinated intervention has picked up after the rate checks from the Federal Reserve Bank of New York late on Friday. It has even been suggested that South Korea could join Japan and the US in joint intervention to strengthen the yen and won against the US dollar, although that appears less likely now President Trump is threatening to raise tariffs on South Korea.        

At the same time, the euro has benefitted from a reduction in political and fiscal risks in France over the past week. The yield spread between 10-year French and German government bonds has narrowed sharply to the lowest level since June 2024 when President Macron dissolved parliament following the European parliamentary elections. Investor confidence in French government bonds has been boosted after the French the budget for this year was pushed through parliament. Prime Minister Sebastien Lecornu invoked Article 49.3 of the French Constitution to push through the 2026 budget without a parliamentary vote. It allowed the government to adopt the legislation without a vote. The decision prompted both the hard-left (LFI) and the far-right (National Rally) to both file no-confidence motions but Prime Minister Lecornu was able to survive both votes thanks mainly to the Socialists refusing to back censure, after winning concessions in the budget. While the use of Article 49.3 to pass the budget again highlights how fragmented parliament is in France making it challenging to pass legislation, the good news is that it pushes political and fiscal risks further into the future. It fits with our view that French political risks are likely to become more important for euro performance in 2027 when the Presidential election is held.  

EUR/USD VS. SHORT-TERM YIELD SPREAD

Source: Bloomberg, Macrobond & MUFG GMR

JPY: Yen to re-weaken if no intervention follow through

The yen has started to give back some of its recent gains overnight. After hitting a low of 153.31 yesterday, USD/JPY has risen back up towards the 155.00-level. It still leaves the pair almost 5 big figures lower than the high from Friday before the abrupt sell-off triggered by intensified speculation over the risk of imminent intervention to support the yen. There haven no fresh verbal intervention warnings from Japanese officials overnight which have encouraged the partial reversal lower for the yen. Bloomberg reported yesterday that the latest current account data from the BoJ indicated that there was no clear sign that Japan intervened on Friday. There was only a relatively minor discrepancy between the BoJ’s current account data and forecasts from money brokers before last Friday making it difficult to conclude that authorities had intervened. However, market participants are likely to remain on high alert for intervention in the near-term after the clear stepped up warning from policymakers since the end of last week.     

Bloomberg have also run a report overnight speculating over potential allocation shifts from the Government Pension Investment Fund to support the domestic government market. The reports cites analysts views that the GPIF could provide support by increasing its asset allocation to domestic government bonds coupled with a reduced target for holdings of foreign bonds. The GPIF completed its last five-yearly asset allocation review in 2025, but it has not stopped speculation that another early review could take place in light of the jump in domestic government bond yields. The GPIF currently has an allocation target  of 25% for domestic bonds which is the same for domestic stocks, foreign bonds and foreign stocks. According to the report, the GPIF declined to comment on the prospect of any change. While the report appears to be based only on speculation, it does highlight that Japan is able to redirect its vast domestic savings to provide more support for the JGB market if required.              

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com