FX Weekly

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Intervention risk helping to discourage JPY selling

FX View:

The USD has rebounded over the past week following President Trump’s decision to nominate former Federal Reserve Governor Kevin Warsh as the next Fed Chair. His nomination has helped ease concerns about potential further attacks on the Fed’s independence, as he is widely viewed as a credible and market‑friendly candidate among investors and central bankers. However, we still believe this development does not close the door on additional Fed rate cuts later this year, which we expect would ultimately contribute to renewed USD weakness. At the same time, JPY selling resumed ahead of Japan’s lower house election. The LDP outperformed expectations, securing a supermajority on its own, which gives Prime Minister Takaichi a strong mandate to continue advancing her policy agenda. While persistent fiscal concerns are likely to remain a drag on the JPY, the risk of official intervention is helping to limit selling as USD/JPY moves back into the high‑150s.

AUD OUTPERFORMS EVEN AS USD REBOUNDS BROADLY

Source: Bloomberg, 18:00 GMT, 6th February 2026 (Weekly % Change vs. USD)

Trade Ideas:

We are maintaining our long EUR/JPY and long AUD/GBP trade ideas.

IMM Positioning:

The latest IMM weekly positioning data for the week ending 3rd February shows that Leveraged Funds have sharply increased their short USD positions. Total USD shorts have risen to their highest level since early October 2024, just before President Trump’s U.S. election victory. This shift indicates that speculators are increasingly positioning for further USD weakness following the recent rise in U.S. political uncertainty.

Sentiment Analysis on the latest BoE MPC Summary and Minutes:

The BoE’s surprisingly tight vote has effectively laid the groundwork for a rate cut at the March meeting. Our analysis shows policymakers are increasingly confident in the ongoing disinflation process, with the MPC narrative shifting decisively from inflation dynamics toward degradation in activity and labour‑market conditions.

FX Views

USD/JPY: Assessing fallout from Japan election & Trump’s Fed chair pick  

It has been a volatile trading session for the yen overnight following the ruling government’s decisive victory in the weekend’s lower house election. The yen initially weakened, pushing USD/JPY up to a high of 157.76, but has since reversed all of those gains, falling back to a low of 156.22. The election outcome has also triggered a strong rally in the Japanese equity market, lifting it to fresh record highs. The Nikkei 225 index has risen by roughly 4%. In contrast, Japanese government bonds have come under further selling pressure. Yields on the 2‑year and 10‑year JGBs have increased by around 3bps and 6bps respectively, while the 30‑year yield is currently unchanged on the day.

Takaichi‑related trades have been reinforced after confirmation that Prime Minister Takaichi’s decision to call a snap election has paid off decisively, giving her a strong mandate to continue implementing her reflationist policy agenda. The LDP secured 316 seats, giving it the largest share of lower‑house representation of any party in post‑war Japan. The party has achieved a two‑thirds supermajority on its own, and a combined 352 out of 465 seats in the lower house when including its coalition partner, the Japan Innovation Party. Such a commanding supermajority in the lower house will make it even easier for the coalition to pass legislation. It also means that any bills rejected by the upper house, where the coalition does not hold a majority, can be overridden and passed again in the lower house further strengthening the government’s legislative authority.

Following the decisive election victory, Prime Minister Takaichi indicated that she intends to advance a national discussion on suspending the food sales tax for two years. Importantly, she noted that this measure would be implemented without issuing new government bonds, despite the estimated fiscal cost of around JPY 10 trillion. Instead, she plans to fund the temporary tax freeze by revising subsidies and tax exemptions, while acknowledging that differing views among political parties mean that further discussions will be required. She also committed to compiling a mid‑term report on the sales tax before the summer, which will help guide the next phase of policymaking. At the same time, she attempted to reassure markets and the public that her administration will continue to pursue “responsible, proactive spending” despite the shift in tax policy. In addition, Prime Minister Takaichi signalled her intention to create conditions for a future vote on constitutional amendments, made more feasible by the coalition’s newly secured super majority. Potential revisions could include changes to the “peace clause.” However, she cautioned that Japan still seeks stable and constructive ties with China, signalling a desire to balance domestic political momentum with external diplomatic considerations. Despite the strength of the coalition’s lower‑house position, pushing constitutional amendments through remains challenging. Any change requires a two‑thirds majority in both houses followed by approval in a national referendum.

CRUSHING VICTORY FOR LDP

Source: NHK & MUFG GMR (Number of seats out of 465 in lower house)

JPY SHORTS CUT BACK AHEAD OF ELECTION

Source: Bloomberg, CFTC, Macrobond & MUFG GMR

Yen weakness following the election result has been limited by the heightened risk of currency intervention as USD/JPY moves back into the high 150s. Japan’s top currency official, Atsushi Mimura, warned that authorities are monitoring market developments with “a high sense of urgency.” His remarks followed comments from Finance Minister Satsuki Katayama, who stated after the election victory that she would communicate with financial markets on Monday if necessary. She reiterated that “Japan and the US have signed a memorandum of understanding which stated that we can take decisive measures against rapid movements out of line with fundamentals. That certainly includes intervention.” The persistent threat of intervention has helped to dampen further yen selling in the aftermath of the lower house election. Nevertheless, the yen remains vulnerable to renewed weakness if market participants continue to harbour concerns about the policy direction under Prime Minister Takaichi’s administration. The latest IMM positioning report, released on Friday, shows that Leveraged Funds have been scaling back short yen positions in response to rising intervention risks. Yen shorts have been reduced for three consecutive weeks, falling by nearly half during that period. This unwinding highlights growing caution among speculative traders as authorities signal a lower tolerance for excessive yen depreciation.

One other reason why USD/JPY has risen back up to the high 150.00’s over the past week has been the broad‑based rebound for the USD after it threatened to break lower at the start of the year. After hitting a low of 95.551 on 27^th January, the dollar index has climbed back into the middle of the 96.000–100.000 trading range that has held since Q2 of last year. The USD appeared poised for another leg lower earlier this year as heightened U.S. policy uncertainty drew comparisons to last year’s sharp sell‑off following President Trump’s “Liberation Day” tariff announcement in April. U.S. policy uncertainty increased following a series of foreign‑policy actions involving Venezuela, Greenland, and Iran. Oil prices are still pricing in roughly an USD8‑per‑barrel risk premium to reflect potential supply disruptions stemming from the ongoing threat of U.S. military action against Iran. Sentiment was further unsettled after President Trump delivered another blow to the Fed’s independence when it was revealed that the Department of Justice had opened a criminal investigation into Fed Chair Powell. The USD sell‑off then intensified after reports of New York Fed rate checks on 23^rd January and comments from President Trump describing the weaker dollar as “great,” which reinforced the perception that the administration wanted the USD to weaken further.

HIGHER POLICY RISK PREMIUM WAS PRICED INTO USD

Source: Bloomberg, Macrobond &  MUFG GMR

POLICY STANCE INDEX FOR KEVIN WARSH

Source: The Economist

However, the USD failed to break lower on a sustained basis and has since rebounded after the Trump administration announced steps that helped restore investor confidence and encouraged market participants to scale back the U.S. policy‑risk premium embedded in the currency. First, U.S. Treasury Secretary Scott Bessent stated unequivocally that the United States is “absolutely not” intervening to support the JPY or planning to do so, reaffirming that the U.S. remains committed to a “strong dollar policy.” These comments eased concerns that the administration might actively pursue a weaker USD to improve trade competitiveness and support the manufacturing sector. The implementation of Trump’s trade tariffs has contributed to outsized volatility in the monthly US trade figures over the past year. Even so, the trade deficit for the year as a whole remained elevated at roughly USD 900 billion, broadly unchanged from the previous twelve‑month period. Persistent U.S. trade deficits fundamentally reflect the fact that the US invests more than it saves domestically, requiring it to borrow the difference from abroad. Large federal budget deficits, low household saving rates, and strong domestic investment demand continue to drive substantial US trade deficits despite higher import tariffs.

Secondly, the USD rebound has also been supported by President Trump’s decision to nominate former Fed Governor Kevin Warsh to succeed Jerome Powell as Fed Chair when Powell’s term ends in May. Warsh is widely viewed by market participants and central bankers as a credible and stabilising choice, which has helped ease fears of a shift toward more unorthodox policy-making at the Fed. The Economist hashighlighted how Warsh’s views on monetary policy have evolved over time. An analysis of nearly 200 of his speeches, media appearances, and research papers over the past two decades shows that he has historically been aligned with the hawkish camp. More recently, however, he has clearly adopted a more dovish tone since President Trump secured a second term. Warsh has expressed optimism that stronger productivity growth driven by the rollout of AI technologies and the Trump administration’s deregulation agenda will permit the US economy to grow at a faster pace without generating inflationary pressures. In addition to this potential positive supply shock, disinflationary forces remain evident. Labour demand is weak, reflecting ongoing corporate caution over hiring. Job openings continued to decline sharply toward the end of last year, falling to their lowest level since September 2020 during the initial post‑COVID reopening. Moreover, the inflationary impact of higher tariffs is expected to peak before fading as the year progresses. In these conditions, we continue to forecast three additional Fed rate cuts in 2026 which is an important assumption underpinning our outlook for further USD weakness this year (click here).

One policy area where Kevin Warsh has been consistently hawkish is his criticism of the Fed’s significant balance sheet expansion, which he argues has blurred the boundaries between fiscal and monetary policy. This has fuelled speculation that he may advocate for further balance sheet reduction. The Fed’s balance sheet has already declined in recent years from roughly USD 9 trillion to USD 6.6 trillion as it implemented quantitative tightening (QT). However, a further reduction would risk eroding bank reserves, potentially pushing the system from an “ample” level of reserves into a “scarce” one. Such a shift could place upward pressure on short-term interest rates. These concerns led the Fed to restart short-term Treasury bill purchases in December, at a pace of roughly USD 40 billion per month, to accommodate projected growth in demand for Fed liabilities. By early February, the Fed had already purchased more than USD 90 billion. As a result, any significant additional balance-sheet reduction would likely require a decline in demand for reserves. Achieving that would necessitate adjustments to the regulatory and supervisory framework. The trade-off, however, is that smaller liquidity buffers could weaken the financial system’s resilience during periods of market stress. There is also a risk that further balance sheet shrinkage could lead to an undesirable tightening of financial conditions, including placing upward pressure on the USD. Some modest additional reduction in the balance sheet is possible if reserves are kept stable, but doing so would require careful coordination with the Treasury. Consequently, a substantial further shrinking of the Fed’s balance sheet is unlikely to be pursued as early as this year.

WARTSH HAS CRITICISED BIGGER FED BALANCE SHEET

Source: Bloomberg, Macrobond & MUFG GMR

RESERVE BALANCES AT FED REMAIN ELEVATED

Source: Bloomberg, Macrobond & MUFG GMR

Weekly Calendar

Source: Bloomberg & MUFG GMR

Key Events:

• Market attention at the start of this week is focusing on the fallout from the Lower House elections that took place in Japan on 8^th The decisive election victory for the LDP who secured a super majority has injected fresh momentum into Takaichi trades. Market participants will be listening closely for any clues over any potential changes to the government’s policy agenda.
• The main economic data releases in the week will the delayed US nonfarm payrolls and CPI reports for January. Market participants will be watching closely to see if private employment picked up further at the start of this year. The Fed expressed more confidence over solid growth in the US and was less concerned over downside risks to the labour market at the January FOMC meeting. The sharp drop in job openings in December and jump in Challenger job cuts in January which were the most at the start of calendar year since 2009 have fuelled concerns that the Fed may have been premature in judging that downside risks have eased.
• Comments from Fed Governors Miran and Waller, and voting FOMC Fed Presidents Hammack, Logan and Bostic will be scrutinized closely to assess the likelihood of further easing in the near-term. US rate market participants continue to judge that the Fed will leave rates on hold at least until the new Fed chair is in place in June. The release of the latest US retail sales report for December is expected to provide further confirmation that consumption remained strong at the end of last year although slowing from robust growth of 3.5% recorded in Q3.