FX Weekly

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Positive USD momentum set to reverse

FX View:

The US jobs report on Friday failed to shift current market pricing on the potential for a pause from the Fed that could help provide the dollar with support over the short-term. The labour market data confirmed ongoing weakness in demand for labour but the data wasn’t weak enough to alter expectations. Hence market pricing continues to point to June being the timing of the next rate cut. The positive dollar momentum after the release of the data has faded however with the news that the Federal Reserve has been served grand jury subpoenas from the DoJ threatening a criminal indictment. Fed Chair Powell has delivered a strong response with a statement expressing the view this had nothing to do with the building renovations and everything to do with attempting to pressure the Fed to lower interest rates. This has seen the week commence with triple selling of US assets. Focus this week will also shift to politics in Japan with media reports strongly suggesting PM Takaichi will call an election when the Diet reconvenes on 23rd Jan.

1ST WEEK OF 2026 SEES NEAR BROAD-BASED US DOLLAR STRENGTH

Source: Bloomberg, 16:45 GMT, 9th January 2026 (Weekly % Change vs. USD)

Trade Ideas:

We are recommending a new long EUR/JPY trade idea, and continue told a long AUD/GBP trade idea.

JPY Flows – High Frequency:

This week we assess the weekly portfolio flow data that revealed reduced flows over the turn of the year.

FX Options Weekly Flow:

FX options flow is sending a straightforward message this week — USD/JPY upside remains in demand, demand for EUR/USD upside has softened in near‑term but still supported at medium-term horizons, and GBP/USD has structurally bearish flows despite a brief December bounce.

FX Views

JPY: Back in the danger zone

The US dollar remains in the 96-100.00 range on a DXY basis that has largely held since June of last year but early trading this year shows some modest improvement in dollar sentiment with some renewed positive momentum. The release of the US jobs report on Friday passed with no significant impact on pricing. Fed rate cut expectations remain largely unchanged and the dollar is marginally weaker. As is often the case, the NFP report was a mixed bag. The NFP print was a little weaker than expected (+50k vs +70k expected) especially considering the -76k previous two-month revision. The breakdown of the NFP also saw an increase in the number of sectors recording job losses. Manufacturing, construction, trade/transport, retail and temp help all recorded job losses. Hours worked also dropped, which tends to be a precursor of weakening activity. However, the unemployment rate decline (4.375% from 4.536%) and the pick-up in the YoY AHE rate to 3.8% will be reason for caution within the Fed. Our overall takeaway from Friday’s data is that not a lot has changed. The jobs data has told us nothing new and subdued labour market growth continues but with little evidence of deterioration or imminent pick-up. That initially helped the US dollar but the subpoena delivered to the Fed by the DoJ is set to drive dollar sentiment initially with the CPI data tomorrow also key for dollar direction.

Yomiuri published a story on Friday evening that PM Takaichi is considering dissolving parliament when it reconvenes on 23^rd Jan and holding an election (8^th or 15^th Feb were mentioned as possible dates). Yomiuiri is a right-leaning news outlet and has closer ties to Takaichi, so we are inclined to give this report credibility. The Nikkei today has followed with the same and a holiday in Japan today means there has been no denial. PM Takaichi’s approval rating ranges from 78% (JNN today) to 68% (Kyodo) and hence it makes sense to possibly consider this strategy. The LDP currently holds 199 seats and is dependent on the support of Japan Innovation Party. Given Takaichi’s reflationist economic policy approach, winning a majority through an endorsement from the electorate would fuel expectations of more policies of the same. The JGB market when open tomorrow is likely to see higher yields on renewed political risks.

That also spells trouble for the yen. Given the Fed subpoena development USD/JPY has failed to gain traction and for now expressing political risks for the yen is best done in non-dollar yen crosses. USD/JPY is already in the ‘danger zone’ of levels where the Japanese authorities are expected to intervene to halt yen depreciation. The yen pretty much matched the bad performance of the dollar last year and if dollar prospects improve, it could quickly translate into a sudden spike higher for USD/JPY. Suddenly a retest and breach of 160 no longer looks unrealistic. Since July 2023, USD/JPY has traded in a 140-160 range and the vast majority of the market had assumed that the break of that range would ultimately come to the downside (including us). However, the policy mix in Japan is now far less favourable for the yen. We argued in the 2026 Annual FX Outlook (here) that the authorities may be compelled to shift that policy mix in order to restore confidence and avoid a renewed spell of yen depreciation. In our final FX Weekly of 2025 (here) we expressed an assumption that Governor Ueda would communicate a stronger message to the markets on future hikes when the BoJ raised rates in December – that didn’t happen and instead Governor Ueda repeated previous comments that suggested a continued very cautious approach to lifting rates. Yen downside risks have clearly increased despite intervention risks.

PAYROLL WEAKENING TREND INTACT AFTER DEC DATA

Source: Bloomberg, Macrobond & MUFG GMR

STEEPENING 2S10S SUGGESTS BOJ TOO CAUTIOUS

Source: Bloomberg, Macrobond & MUFG GMR

The continued message of caution on BoJ policy only adds to speculation that Japan is pursuing a policy more aligned with managing its debt servicing costs and reducing its debt burden relative to nominal GDP rather than achieving its price stability goal – a scenario known as ‘fiscal dominance’. This perception has been reinforced by PM Takaichi’s first fiscal stimulus package, which was larger than expected amounting to JPY 17.7trn. The post-covid period in Japan also suggests this policy is now beginning to work. The chart below shows the marked pick-up in nominal GDP growth and the 5-year average of annual nominal GDP growth now stands at 3.5%, the strongest growth rate since 1995. Debt servicing costs remain well below this rate which will see debt as a percentage GDP coming down.

The pursuit of this policy mix would therefore imply real yields in Japan would remain negative for longer – a scenario that would drive the yen further weaker. While stronger nominal GDP growth has its benefits, we do still maintain that politically this policy mix has its limits as Japanese households view yen depreciation negatively and link it to the cost of living crisis. We see the need for intervention to counter investor concerns over inflation remaining higher but that intervention will only be worthwhile if the BoJ equally steps up its rhetoric on these risks and indicates the scope for being more active in raising rates if required. The risk is that intervention takes place without such communication from the BoJ – a scenario in which the drop in USD/JPY would likely be met with renewed buying and the need for further intervention. Other factors could help limit yen selling. Sharper cuts in rates from the Fed, sharper energy price declines and/or a notable global equity market correction would all help curtail yen selling.  

Policy status quo certainly increases the risk  of further yen selling while the prospects of an election victory and majority in the Lower House for PM Takaichi will only increase conviction in selling the yen at these levels.  

NOMINAL GDP YOY GROWTH IN JAPAN HAS AVERAGED 3.5% OVER LAST 5YRS, STRONGEST SINCE 1995

Source: Bloomberg, Macrobond &  MUFG GMR

STEEPER JGB CURVE COULD EXTEND ON ELECTION SPECULATION DRAGGING YEN WEAKER

Source: Bloomberg, Macrobond &  MUFG GMR

GBP: Will talk of closer alignment with EU help to strengthen GBP?  

The GBP has continued to rebound at the start of 2026, extending its advance following the Autumn Statement in November. After hitting a high of 0.8865 on 14^th November, EUR/GBP has since retreated toward support from the 200-day moving average, at around 0.8640, at the beginning of this year. The move lower for EUR/GBP accelerated last week after the pair broke back below the 0.8700 level. Over the same period, cable has climbed from a low near 1.3000 in early November to a high of 1.3568 last week. The latest IMM positioning data shows that leveraged funds had sharply reduced long GBP positions, briefly flipping to shorts by late November. However, leveraged funds have since been rebuilding long GBP positions throughout December.

Price action and positioning data highlight that the risk premium priced into GBP ahead of the Autumn Statement has now been removed, helping the currency to rebound. Investor concerns over fiscal and political risks related to the Budget did not materialize as feared, as the government’s plans failed to trigger a sell-off in the gilt market or destabilize the Labour Party leadership. Our analysis (click here) found no strong statistical relationship between long-term gilt yields and GBP performance around the Autumn Statement after adjusting for moves in U.S. Treasury yields. The 30-year gilt yield has since fallen to its lowest level since last April at the start of this year. This marks the longest period below the 200-day moving average since Q3 2024.

The long end of the gilt market has also been supported by the ongoing adjustment lower in short-end yields. The two-year gilt yield has dropped by just over 30bps since early October, falling to fresh lows at the start of this year. Market participants expect the BoE to deliver further rate cuts in the year ahead, with around 45bps of easing priced in by year-end—bringing the policy rate in line with our forecast for a terminal rate of 3.25%. At the December MPC meeting, updated guidance signalled that the pace of easing is likely to slow this year, as the policy rate is now judged to be closer to estimates of the neutral rate. After four quarterly rate cuts delivered in 2025, we expect two further 25bps cuts by the summer and acknowledge the risk of an additional 25bps cut to 3.00% by year-end. In contrast, we have dropped our forecast for one final ECB rate cut this year and now expect the policy rate to remain on hold at 2.00%. Narrowing yield differentials between the UK and eurozone should continue to encourage a weaker GBP against the EUR, lifting EUR/GBP closer to the 0.9000 level in 2026. The relationship has broken down recently as EUR/GBP has corrected lower after the Autumn Statement, but we are not convinced this will be sustained.

WEAKER RELATIONSHIP BETWEEN GILT YIELDS & GBP

Source: Bloomberg, Macrobond & MUFG GMR

BREAKDOWN BETWEEN GBP & YIELD SPREADS

Source: Bloomberg, Macrobond & MUFG GMR

Domestic political developments could become a more significant driver of GBP performance this year. While the risk of an immediate Labour leadership challenge has diminished since the Autumn Statement, it has not disappeared and may resurface ahead of local elections scheduled for 7^th May. On that day, voters in 136 English local authorities—including all 32 London boroughs—will head to the polls. Labour MPs have warned that very poor results could trigger internal discussions over a leadership challenge, which requires 20% of Labour MPs (81) to nominate a candidate. Potential challengers include Manchester Mayor Andy Burnham (though he is not currently an MP), Health Secretary Wes Streeting, and former Deputy Prime Minister Angela Rayner. A leadership contest would heighten political uncertainty and raise concerns about a potential shift to the left, creating renewed unease over fiscal risks—developments that could lead to at least a period of GBP underperformance.

Prime Minister Keir Starmer has warned Labour MPs that removing him would plunge Britain into “utter chaos” and benefit Reform leader Nigel Farage, whose party is currently leading in opinion polls. Starmer cited the instability caused by constant changes in leadership under the previous Conservative government as “amongst the reasons that the Tories were booted out so effectively at the last election.” Brexit-related leadership changes under the Conservatives are now emerging as a visible dividing line between potential Labour leadership challengers. Wes Streeting has expressed the strongest pro-EU stance, supporting rejoining a customs union and closer single-market alignment. This debate appears to have influenced Starmer to show greater openness toward realignment. He stated “I think we should get closer, and if it’s in our national interest to have even closer alignment with the single market, then we should consider that, we should go that far. I think it’s in our national interest to go further.” Starmer emphasized that the UK should look toward the single market rather than customs union for deeper alignment.

The comments are the clearest indication yet that the Prime Minister wants to pursue a closer relationship with Europe across a broader range of areas. The UK is already becoming more aligned on food and agriculture, and he has signalled a willingness to consider deeper alignment in other sectors if it serves the national interest. A shift back toward a closer trading relationship with the EU would likely be welcomed by financial markets and could support a stronger GBP. However, the scope for significant progress during the current parliament is limited by Labour’s election manifesto pledge that “there will be no return to the single market, the customs union, or freedom of movement.” Furthermore, any steps toward realignment would face the risk of being quickly reversed if Reform and the Conservatives were to form a coalition government after the next general election, scheduled for 2029. These hurdles should temper GBP upside potential on the back of optimism over improving UK–EU trade relations.

GBP HAS BEEN REVERSING BREXIT SELL-OFF

Source: Bloomberg, Macrobond & MUFG GMR

UK IS EXPORTING MORE GOODS OUTSIDE OF EU

Source: Bloomberg, Macrobond & MUFG GMR

Weekly Calendar

Source: Bloomberg & MUFG GMR

Key Events:

• US Economic Data Releases in Focus: The main economic data releases in the week ahead are the latest U.S. CPI report for December and the retail sales report for November. The CPI report is expected to show that inflation bounced back in December after the soft reading in November, which was distorted by artificially low prices. November prices were likely downward-biased due to distortions created by the U.S. government shutdown affecting the data collection process. Market participants will attempt to look through the volatility at the end of last year to assess whether there is more evidence of passthrough from tariff hikes. So far, the pick-up in inflation from tariffs has been less than feared, allowing the Fed to lower rates in response to weakness in the labor market. The release of the latest nonfarm payrolls report for December revealed that employment growth remained weak at the end of last year, but the unemployment dropped, giving the Fed some breathing room to leave rates on hold in January. President Trump’s attacks on the Fed’s independence could also make the Fed more reluctant to lower rates in the near-term.
• Supreme Court Ruling on IEEPA Tariffs: Market participants are waiting for the Supreme Court’s decision on the legality of President Trump’s IEEPA tariffs. It is widely expected that the tariffs will be judged illegal. If the tariffs are struck down, it will create additional trade policy uncertainty, including uncertainty over how the Trump administration will respond. Plans are then expected to be communicated as to how the administration intends to replace or replicate the higher tariffs using alternative powers. Refunding tariff revenues collected under the IEEPA could provide additional stimulus for the U.S. economy, alongside the boost to growth from President Trump’s “One Big Beautiful Bill.”