FX Weekly

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USD slide into year-end?

FX View:

Momentum has certainly turned more negative for the US dollar after the broad-based sell-off this week following the FOMC meeting on Wednesday. The US NFP data for October and November will be released on Tuesday and will determine whether this negative momentum is sustained into year-end. We see greater risks of further employment weakness and a continued slide for the dollar into year-end. Next week is the last full week of trading of the year and will be a busy one with the BoE, ECB and the BoJ all meeting. With the yen the only G10 currency that failed to strengthen versus the yen the BoJ will need to not only hike but also send a clear message of the need for further monetary tightening in 2026 in order to ease concerns over being behind the curve. We do expect Governor Ueda to deliver a clear message but if he does not there are risks of JGB and yen selling. We expect the ECB to repeat that policy is “in a good place” while today’s weak GDP data from the UK only reinforces the probability of a 25bp rate cut by the BoE.

JPY LAGS AGAIN AS FOMC FUELS BROAD-BASED USD SELLING

Source: Bloomberg, 13:15 GMT, 12th December 2025 (Weekly % Change vs. USD)

Trade Ideas:

We are recommending a new long AUD/GBP trade idea.

JPY Flows – Portfolio, by investor:

The MoF released the monthly portfolio flow data this week and after strong buying of Japan securities in October, November saw further buying. Japanese investors were modest buyers of foreign bonds.

Sentiment Analysis on the latest Fed Press Conference:

Our latest textual sentiment analysis highlights the rhetoric from this week’s FOMC meeting was marginally more hawkish than at the last FOMC meeting. It was a smaller hawkish shift than took place at the previous FOMC meeting in October.

FX Views

JPY: BoJ needs to send strong message on inflation goal

The US dollar weakened across nearly all G10 currencies this week with only the yen weakening versus the dollar. The Fed cut as expected but moved more quickly than the market expected to commence “reserve Management Purchases” (RMPs) via monthly purchases of T-bills, which will initially amount to USD 40bn per month. The Fed now envisages the secular path of growth in nominal GDP growth requiring around USD 25bn per month growth in balance sheet growth. This helped contribute to the weakening of the dollar following the FOMC meeting. In addition, once Fed Chair Powell was asked why the Fed cut this week in the Q&A, he turned more dovish emphasising the weakness of the labour market was of greater risk. This was more so the case given the Fed’s estimate that NFP is over-reporting jobs growth to the tune of about 60k per month. The 6mth average currently stands at 59k suggesting there has be no employment growth over the last six months. We believe the OIS curve is under-pricing prospects of rate cuts over the coming meetings. The March prising implies only a little over a 50-50 probability of a cut. We expect a cut in March. The dollar has further to fall over the coming months.

There was a wide spread of dots revealed in the Summary of Economic Projections although we don’t agree that the dots suggested necessarily a higher bar to rate cuts going forward. Much was made of the four “silent dissents” given there were six dots for end-2025 indicating a preference for no cut this week. We know two dissented in voting implying there were four more. We think it is unlikely any of those dots are from current FOMC voters as this makes little sense given there were just two dissent. Hence, the four dots likely represent alternate presidents. Hammack, Kashkari, Logan and Paulson become voters in 2026 while Barkin, Bostic (retiring in Feb 2026), Goolsbee and Daly will be voters in 2027. Hammack and Kashkari could well be two of those dots but the other two could be from 2027 voters. That would mean next year we see two hawks being replaced by two hawks. Paulson and Logan are certainly more centrist. In addition, 12 of the 19 dots want one or more hikes next year. 8 of the 19 want more cuts than the median one cut leaving plenty of scope for a shift in that direction if the data justifies it.

FX performance this week is notable in that the yen is the only G10 currency to weaken versus the dollar despite the increased speculation of a rate hike from the BoJ next Friday. Pricing for a hike jumped on 1st December following a speech by Governor Ueda suggested a hike was very possible. Indeed, covering the period since pricing for a Dec hike has jumped from 5bps to 22bps, the yen has barely gained at all. The FX performance points to the need for more than just a hike next week. Lifting rates to 0.75% probably in of itself won’t address those concerns of the BoJ being too cautious on lifting rates. That points to the need, at the very least, for Governor Ueda to signal plans for further rate hikes in 2026 and a repeat of the message that if the economy evolves as expected, further rate increases will be required. There is currently only one further hike priced for 2026, which we believe falls short of what is required. We expect the BoJ to hike twice next year, taking the policy rate to 1.25% by the end of the year. 

TANKAN INFLATION EXPECTATIONS SUPPORT BOJ HIKE

Source: Bloomberg, Macrobond & MUFG GMR

2, 3YR OIS RATES POINT TO 1.50% TERMINAL RATE

Source: Bloomberg, Macrobond & MUFG GMR

The could then be followed by a further hike to 1.50% in 2027, which could be viewed as around the neutral rate. The BoJ has previously cited market analysis suggesting an R* range of -1.0% to +0.5%, or in nominal terms assuming a 2% inflation goal is achieved of 1.0% to 2.5%. Governor Ueda may not necessarily provide an update to that but he could suggest work is being conducted and that initial conclusions suggest more rate hikes are required. The BoJ could possibly provide further info in January when forecasts are updated. The 2-year & 3-year OIS are trading at 1.44% and 1.56% consistent with a policy rate reaching a level of 1.50% in 2027.

In general most of the key Tankan diffusion indices are expected to show a modest improvement with the continued weakness of the yen helping the manufacturing sector and the announcement fiscal stimulus package helping the sentiment of companies exposed to domestic demand conditions. The last survey, released in early October, was conducted with USD/JPY nearly 10 yen lower so we may also see some modest pick-up in companies’ short-term inflation expectations as well.

The fears of the BoJ being behind the curve is reflected in the continued steepening of the JGB curve. The 30-year yield hit a new record closing high of 3.43% last week and the JGB curve is much steeper than in any of the other G4 countries. The 10-year breakeven rate hit a record closing high this week of 1.79%. Foreign investors have been key in being the only consistent source of buying this year and if foreign investors were to turn away from the JGB market, sharper moves higher in yields would be likely. Accepting further yen weakness would also undermine the long-end of the curve. FM Katayama stating that there are benefits as well as costs related to a weak currency does not help counter the rise in inflation expectations.

We expect Governor Ueda to accompany the rate hike with a stronger than usual message of further hikes to come. If that is not forthcoming and Ueda is perceived as being overly cautious on guidance there is a risk of a bout of JGB selling, increased volatility and a renewed slide of the yen. That could force the MoF into meeting a move higher in USD/JPY with yen-buying intervention.

EUR/GBP: Diverging paths for BoE & ECB to encourage stronger EUR

European currencies—SEK, CHF, and EUR—have been the main beneficiaries of the continued correction lower in the USD heading into year-end. After repeatedly failing to break below 1.1500 last month, EUR/USD has moved back into the middle of the 1.1500–1.1900 range that has held since June. The EUR has been supported this month by a hawkish repricing of ECB policy expectations. The 2-year euro-zone government bond yield has jumped by almost 20bps in December as market participants have priced out further ECB rate cuts in the coming years. The euro-zone rate market now sees a higher probability that the ECB’s next policy move will be a hike rather than a cut in 2026. This shift comes at a time when the Fed is still expected to deliver multiple rate cuts next year, even if the timing of the next cut is delayed until the new Fed Chair takes office from the June FOMC meeting. Narrowing yield differentials between the euro area and the U.S. continue to support our forecast for EUR/USD to break back above 1.2000 in 2026.

The hawkish repricing of ECB rate expectations has recently been supported by a stronger run of economic data from the euro area. President Lagarde told the Financial Times this week that ECB staff will likely raise their growth forecasts for the euro area for the second consecutive quarter. The September projections were set at 1.2% for 2025 and 1.0% for 2026, and now compare with current Bloomberg consensus forecasts of 1.4% for 2025 and 1.1% for 2026. This highlights that the euro-area economy has proven more resilient than expected despite trade tensions with the US this year. One caveat is that the recent pick-up in euro-area growth has been driven largely by an outsized contribution from Ireland. IP transfers by large U.S. multinationals for tax purposes have distorted Irish economic data. While the annual growth rate for the euro area rose to 1.4% in Q3, excluding Ireland, growth has remained more stable at around 0.9%. Looking ahead, we remain optimistic about a broader recovery in euro-area growth in 2026, supported by lower inflation boosting real disposable income and consumption, as well as increased fiscal support from Germany. The outlook could improve further if the conflict in Ukraine is resolved in 2026. Natural gas prices in Europe have continued to decline heading into year-end and are currently about 40% lower than at the same time last winter.

The stronger-than-expected performance of the euro-area economy is likely to make the ECB more confident that policy is in a “good place” when it meets in the week ahead (click here). There is now less pressure on the ECB to lower rates further in the coming year. However, we still believe it is premature for the euro-zone rate market to begin pricing in rate hikes as early as next year. Expectations for hikes have been encouraged by comments from hawkish ECB Executive Board member Isabel Schnabel, who stated this week that she is “rather comfortable” with market and survey participants’ expectations for the ECB’s next move being a hike, “albeit not anytime soon.” She noted that “the decline in core inflation has stalled at a time when the economy is recovering, the output gap is closing, and fiscal policy is expanding—all of which would tend to be inflationary.” 

EUR SUPPORTED BY HIGHER SHORT-TERM RATES

Source: Bloomberg, Macrobond & MUFG GMR

EZ GROWTH LIFTED BY IRELAND DISTORTIONS

Source: Bloomberg, Macrobond & MUFG GMR

Nevertheless, the updated ECB staff forecasts are likely to show that inflation is expected to undershoot the target in both 2026 and 2027. ECB Chief Economist Philip Lane expects the undershoot to be small and temporary, and would only respond with further cuts if the risk of a larger and more sustained undershoot increased. One disinflation risk in the year ahead would be if the EUR strengthens further on the back of potential ECB-Fed policy divergence. Dow Jones reported yesterday that the ECB is unlikely to follow the Fed in cutting rates for now but could act again if the EUR appreciates significantly beyond current levels. ECB economists estimate that a 10% appreciation in the EUR can lower inflation by 0.6 percentage points in the following year. We are currently forecasting a further 5–6% appreciation of the EUR against the USD next year, on top of the 13% appreciation this year. This is one reason why we believe risks remain tilted more toward another ECB cut rather than a hike in 2026.

In contrast to the ECB, we expect the BoE to be more active in lowering rates going forward. The BoE’s policy rate remains in restrictive territory, leaving room for further cuts if concerns over persistent UK inflation continue to ease as we anticipate in 2026. BoE estimates for the neutral policy rate range widely between 2.25% and 3.75%, aligning with our forecast for the policy rate to fall to 3.25% by next summer, including another 25bps cut in the week ahead (click here). The vote to cut rates next week is expected to be finely balanced, but we believe further evidence of labour market weakness, slowing economic growth ahead of last month’s Budget, and inflation peaking in recent months will tip the majority in favour of a cut. The main risk to our bearish view and market pricing for another cut lies in the upcoming UK labour market and CPI reports. However, inflation would need to surprise significantly to the upside to derail another cut. We expect a narrow 5–4 or 6–3 vote in favour of a cut, depending on incoming data.

Further gradual BoE rate cuts support our forecast for GBP to weaken against the EUR next year, alongside ongoing UK fiscal and political risks, lifting EUR/GBP closer to 0.9000. The GBP has rebounded since last month’s Budget, which temporarily helped to ease fiscal and political concerns. We expect these risks to flare up again in the first half of next year, when local elections in May will test the Labour government’s popularity and could trigger a leadership challenge.

DISINFLATION HAS STALLED IN SERVICES SECTOR

Source: Bloomberg, Macrobond & MUFG GMR

NARROWING YIELD SPREAD LIFTING EUR/GBP

Source: Bloomberg, Macrobond & MUFG GMR

Weekly Calendar

Source: Bloomberg & MUFG GMR

Key Events:

• Busy Week for G10 Central Banks: A packed schedule of policy meetings is ahead, with the Riksbank, Norges Bank, BoE, and ECB meeting on Thursday, followed by the BoJ on Friday. The BoE and BoJ decisions are expected to draw the most market attention.
• BoJ to Resume Rate Hikes: The BoJ is expected to raise its policy rate by 25bps to 0.75%. The Q4 Tankan survey will be released early in the week but is unlikely to derail plans unless confidence drops sharply. Markets will focus on guidance for the next hike, with a gradual pace assumed and another increase likely by mid-2026.
• BoE Decision to Tip in Favour of Cut: After a narrow 5–4 vote to hold rates previously, the upcoming MPC meeting could shift toward a 25bps cut, possibly by a 5–4 or 6–3 vote. UK labor market and CPI data due ahead of the meeting may influence expectations, with softer conditions strengthening the case for easing.
• Riksbank and Norges Bank Expected to Hold: Both central banks are likely to keep rates unchanged. The Riksbank signals its policy rate will stay at 1.75% “for some time,” supported by stronger Swedish growth. Norges Bank still plans gradual cuts next year, though timing remains uncertain.
• Nonfarm Payrolls in Focus: The delayed November jobs report is the key economic release. After September’s employment pickup, markets are watching to see if labor demand continues to improve.