USD set to record worst annual performance since 2017

USD: FOMC minutes highlight differing views on Fed rate path

The U.S. dollar strengthened overnight, supported by the release of hawkish minutes from the December FOMC meeting. This helped lift the dollar index back above the 98.000 level, a key support area since mid-year. Despite the rebound, the dollar remains on track for a full-year decline of 9.4%, which would mark the largest calendar-year sell-off since 2017. Both periods coincided with the first years of President Trump’s two terms in office. The dollar regained some ground in 2018 when the index rose by 4.4%, but we do not expect a similar recovery in the year ahead. Instead, the weakening trend is likely to extend into 2026. The dollar is no longer as overvalued following this year’s sharp sell-off, driven by heightened U.S. policy uncertainty under the Trump administration and the Fed’s decision to resume rate cuts. These developments have prompted market participants to increase hedging on U.S. asset holdings, and we expect selling pressure on the dollar to persist into 2026. Yield differentials between the U.S. and other major economies should continue to narrow as the Fed cuts rates further, while other G10 central banks have already reached the end of their easing cycles.

The minutes from the December FOMC meeting, released overnight, revealed that most participants would support additional rate cuts if inflation continues to decline as expected. However, views on the future policy path remain divided. While “most participants” backed the December rate cut and signalled openness to further easing, the minutes hinted at a likely pause at the January meeting. The updated dot plot from December showed that six of the 19 participants favoured holding rates steady, and two voting members—Chicago Fed President Goolsbee and Kansas City Fed President Schmid—dissented against the latest cut. The minutes noted that participants expressed a range of opinions on the restrictiveness of current policy, suggesting that the scope for further cuts could become more limited as rates approach neutral. Some participants argued it may be appropriate to keep the target rate unchanged for “some time” to assess the lagged effects of recent moves toward neutrality on the labour market and economic activity, while also allowing time to gain confidence that inflation will return to 2%.

Overall, the minutes provide additional context on December’s hawkish rate cut but do not alter our view that further cuts are likely in 2026, following a probable pause in January. The timing of the next cut could be delayed if the U.S. labour market shows signs of improvement, posing upside risks for the dollar.

CATCH UP CNY STRENGTH HEADING INTO 2026

Source: Bloomberg, Macrobond & MUFG GMR

CNY: Faster pace of appreciation attracts attention heading into 2026

The recent acceleration in renminbi appreciation is drawing increased market attention as we head into 2026. USD/CNY is on track for its seventeenth consecutive daily decline and has broken below the 7.000 level for the first time since May 2023. The PBoC has also been setting progressively lower daily fixes, with the latest at 7.0288, signaling that policymakers are now more comfortable allowing the renminbi to strengthen against the U.S. dollar after maintaining stability earlier in the year. By keeping USD/CNY stable during the sharp U.S. dollar sell-off earlier this year, the trade-weighted renminbi weakened significantly, boosting China’s export competitiveness. The CFETS renminbi index fell about 6.7% between January and July but has since rebounded by roughly 2.5%.

The decision to permit recent renminbi gains may reflect greater confidence in China’s ability to withstand trade disruptions. The country’s trade surplus reached a record USD 1.18 trillion over the past twelve months through November. Downside risks to U.S. trade have also eased following the extension of the trade truce by twelve months and a 10% reduction in tariffs on Chinese goods. Still, the pace of appreciation has sparked some caution. The People’s Daily recently urged market participants to remain rational in their currency expectations, while other domestic media warned against one-way bets. The PBoC’s annual financial stability report emphasized maintaining exchange rate flexibility, guiding expectations, and guarding against “overshooting risks.” Reports also suggest Chinese state banks stepped up U.S. dollar purchases after USD/CNY broke below 7.0000.

Overall, these developments support our forecast for a stronger renminbi in 2026, though we doubt the recent rapid appreciation will persist. The currency was further buoyed overnight by stronger-than-expected December PMI surveys, reversing prior declines in business confidence.

Finally, we would like to wish all our readers a Happy New Year.

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Source: Bloomberg & Investing.com