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Monthly Foreign Exchange Outlook

DEREK HALPENNY
Head of Research, Global Markets EMEA and International Securities

Global Markets Research
Global Markets Division for EMEA
E: derek.halpenny@uk.mufg.jp

LEE HARDMAN
Senior Currency Analyst

Global Markets Research
Global Markets Division for EMEA
E: lee.hardman@uk.mufg.jp

LIN LI
Head of Global Markets Research Asia

Global Markets Research
Global Markets Division for Asia
E: lin_li@hk.mufg.jp

KHANG SEK LEE
Associate

Global Markets Research
Global Markets Division for Asia
E: khangsek_lee@hk.mufg.jp

MICHAEL WAN
Senior Currency Analyst

Global Markets Research
Global Markets Division for Asia
E: ｍichael_wan@sg.mufg.jp

LLOYD CHAN
Senior Currency Analyst

Global Markets Research
Global Markets Division for Asia
E: lloyd_chan@sg.mufg.jp

SOOJIN KIM
Analyst, ESG and Emerging Markets Research – EMEA

DIFC Branch – Dubai
E: soojin.kim@ae.mufg.jp

_{MUFG Bank, Ltd.
A member of MUFG, a global financial group}

February 2026

KEY EVENTS IN THE MONTH AHEAD

1) SUPREME COURT TO RULE ON IEEPA TARIFFS?

The US dollar has weakened at the start of this year, driven by rising uncertainty surrounding US policy. Recent foreign policy action including the removal of Venezuelan President Nicolás Maduro, threats to impose tariffs on NATO allies such as France, Germany, and the UK over issues related to Greenland, and renewed threats of military action against Iran have all contributed to elevated policy risk. Additionally, President Trump has intensified pressure on the Federal Reserve’s independence by opening a criminal probe into Chair Powell’s congressional testimony regarding the renovation of the Fed’s headquarters. This has led market participants to price a higher US policy risk premium into the dollar, similar to the reaction following last year’s “Liberation Day” tariff announcement. As a result, the US dollar has weakened even as the domestic economy continues to grow solidly and expectations for Fed rate cuts have been reduced. On the other hand, President Trump’s nomination of former Fed Governor Kevin Warsh as the next Fed Chair has helped ease concerns about the Fed’s independence and prevented the dollar from falling further. However, the upcoming Supreme Court ruling on the legality of President Trump’s IEEPA tariffs remains another significant source of uncertainty, with a decision potentially coming as early as this month.

2) LOWER HOUSE ELECTION IMPORTANT FOR FISCAL RISKS IN JAPAN

The Lower House election is scheduled for 8th February, and recent opinion polls suggest that the ruling coalition comprising the Liberal Democratic Party and the Japan Innovation Party is on track to strengthen its majority in the chamber. If confirmed, this outcome would give Prime Minister Sanae Takaichi a stronger mandate to advance her reflationist policy agenda, which would likely reinforce downward pressure on the yen. Concerns over Japan’s fiscal risks and the gradual pace of Bank of Japan rate hikes have already contributed to pushing USD/JPY back toward the 160.00 level in January. This occurred before speculation about possible joint foreign‑exchange intervention by Japan and the United States sparked a sharp yen rebound. While there has been no confirmation that direct intervention took place, it may become necessary if Prime Minister Takaichi consolidates her authority following the election outcome.

3) LUNAR NEW YEAR HOLIDAY SPENDING WILL BE GIVEN ATTENTION

The government kickstarted the first year of the 15th Five-Year Plan with a slew of policy measures from monetary easing to extending fiscal subsidies programs, among others. The flagship consumer goods trade-in program has been extended to this year as well with the first batch of funds worth RMB 62.5bn allocated in late December. With absence of monthly macro data this month (January-February period to be reported together in March), lunar new year holiday spending will be the first-hand data to measure the effect of recently announced policies on boosting consumption amidst recent weakening trend. Apart from that, the government will be in preparation for the March NPC and that means a low likelihood of introducing new policies in the month as well.

Forecast rates against the US dollar - End-Q1 to End-Q4 2026

Notes: All FX rates are expressed as units of currency per US dollar bar EUR, GBP, AUD and NZD which are expressed as dollars per unit of currency. Data source spot close; Bloomberg closing rate as of 4:30pm London time, except VND which is local onshore closing rate. All consensus forecasts are Bloomberg sourced.

US dollar

MARKET UPDATE

In January the US dollar weakened notably against the euro in terms of London closing rates, from 1.1756 to 1.1881. In addition, the dollar weakened against the yen, from 156.59 to 154.32. The FOMC at its meeting in January kept the range for the federal funds was unchanged at 3.75%-4.00%. The FOMC confirmed the end of QT effective 1st December last year with the Fed no longer reducing UST bond holdings by USD 5bn per month. MBS holdings would continue to decline but would be offset by buying of US T-bills, initially amounting to around USD 40bn per month.

OUTLOOK

The US dollar, on a DXY basis, fell notably in January, by 2.6%, which followed a 9.4% drop in 2025. President Trump’s unpredictable policy actions in attacking Venezuela, threatening to take Greenland, threatening numerous countries with additional tariffs and continuing to criticise Fed Chair Powell have all combined to undermine confidence in the dollar. At month-end it was confirmed that President Trump has chosen Kevin Warsh as his nomination for Fed Chair. The rebound of the dollar on this news is understandable (Warsh has more credibility than say Hassett or Rieder) although we do not see this choice as altering the medium-term outlook for the dollar and our view of 2026 being another year of dollar depreciation. Warsh last spoke publicly on Fed policy in July and was strongly endorsing Fed cuts and suggesting fundamental change at the Fed was required. Warsh is also strongly in favour of the Fed’s balance sheet being a lot smaller and wants a clear division between UST bonds and the Fed. Further rate cuts and a renewed roll-off of UST bonds from the balance sheet will likely lead to a steeper yield curve. In addition, given he is a more credible choice and given his strong views on rate cuts, we would argue he is more likely to deliver on that by bringing the FOMC with him. Hassett or Rieder may have struggled to do that. So Warsh’s credibility in fact makes rates cuts more likely in the early period of his time as Fed Chair.

Trade tariff uncertainties could increase again if the Supreme Court rules against the use of IEEPA. Trump likely has a Plan B but we doubt tariffs will on balance increase this year relative to last year given it’s an election year. The jobs market is set to remain weak and assuming no net increase in tariff levels this year we expect inflation to slowly decline toward the 2.0% target. GDP growth may remain resilient but it is developments in the labour market and inflation that will determine Fed action and we continue to expect three rate cuts, more than currently priced.

Further rates cuts and the predictable uncertainties associated with the Trump presidency points to further dollar depreciation this year. Trump described the dollar’s performance as “great” in January and the Fed checking rates in USD/JPY will ensure investors continue to suspect the Trump administration wants a weaker dollar. A steeper UST bond curve tends to coincide with a weakening dollar.

INTEREST RATE OUTLOOK

* Interest rate assumptions incorporated into MUFG foreign exchange forecasts.

We now expect a slightly longer Fed pause and have pushed back our next cut to April 2026. This would be Powell’s last FOMC meeting as Chair where we expect that he will still favour cutting if the data warrants it (we think the jobs data will remain weak throughout 2026). Based on our bearish leaning view, we still believe that the Fed will cut 3 times to/under neutral in 2026. However, we have compressed our view by removing the optionality of a 4th cut in late Q3 following the January FOMC press conference where Chair Powell stressed the importance of protecting Fed independence and his advice to his successor to avoid “get(ting) pulled into elected politics” (code for not cutting so close to the midterm elections). With the recent news that Kevin Warsh is being nominated as Powell’s successor, and given that Warsh used to work at the Fed, he can gain confidence of others at the Fed to cut for the right reasons. Although we removed one cut, we still see cuts driving the whole UST curve (outside of 30s) sub the 4% level with 3.5% resistance for 10s. However, we slightly adjusted some of our point estimates upward by 12.5bps in Q2. (George Goncalves)

FEDERAL RESERVE BANKS TOTAL ASSETS

Source: Bloomberg, Macrobond & MUFG GMR

DXY VS. SHORT-TERM YIELD SPREAD

Source: Bloomberg, Macrobond & MUFG GMR

Japanese yen

MARKET UPDATE

In January, the yen strengthened further versus the US dollar in terms of London closing rates from 156.59 to 154.32. The yen also recovered versus the euro from 184.09 to 183.35. The BoJ at its meeting in January kept the key policy rate unchanged at 0.75%, following the 25bp hike in December, the second 25bp rate hike since 2007. The BoJ is also continuing with the policy of cutting JGB monthly purchases at a pace of JPY 400bn per quarter but announced in June that the pace of reduction will be reduced to JPY 200bn per quarter from Q2 2026.

OUTLOOK

The yen began 2026 in much the same way as it ended 2025, under selling pressure fuelled by concerns over Japan’s fiscal and monetary policy mix. The extension of yen selling momentum was fuelled by the decision of PM Takaichi to hold a snap general election on 8th February. An endorsement through a successful general election would likely mean more ‘reflationist’ type policies that have been a key driver of yen selling. However, reports that the Federal Reserve ‘checked rates’ in USD/JPY on 23rd January prompted a surge in yen buying that signals to us a more concerted effort to stem a break of the 160.00-level. It has since been confirmed that Japan did not directly intervene in January. But the real impact was from the involvement of the US that raises the prospect of joint intervention going forward. History certainly points to success when conducted jointly. Still, we suspect the US would only ever get involved under circumstances of a change in the unfavourable policy mix, and more specifically a commitment by the BoJ to act more aggressively than current market pricing implies in raising its key policy rate. Broader US dollar debasement fears certainly helped reinforce the move lower in USD/JPY. We see a high chance of an April BoJ hike.

High approval ratings provide some logic to the decision of PM Takaichi to hold a snap election. The LDP and Ishin hold 233 seats, the bare minimum for a majority, and look set to increase this combined total. A Yomiuri poll indicated the possibility of the LDP alone winning an outright majority. However, the strategy is not without risks. New Komeito does have broad-based support that was too low to win outright and hence voters in the past tended to vote LDP. That vote is now lost and the momentum in LDP voting in the last two country-wide elections has indicated declining popularity. We assume the FX impact as simply being the larger the victory for PM Takaichi the greater the downside risks for the yen. A poor result and/or resignation of Takaichi (unlikely) would see USD/JPY fall back below the 150.00.

A victory in the election (any number of seat gain) would be viewed as an endorsement for reflationary policies. However the extent of victory is important, and opposition to a food sales tax suspension is a plausible outcome. Either an abandonment of that plan or a faster pace of BoJ rate hikes is likely and that along with Fed rate cuts and debasement fears should be enough to see USD/JPY decline.

INTEREST RATE OUTLOOK

* Interest rate assumptions incorporated into MUFG foreign exchange forecasts.

After an increase of 97bps last year, the 10-year JGB yield in January jumped by a further 19bps to close at 2.26%. There was a bout of sharp volatility with yields on all tenors spiking higher in response to the decision of PM Takaichi to hold a snap election on 8th February. Is Japan running a policy mix that reflects ‘fiscal dominance’ – when policy is geared more toward managing debt sustainability risks rather than price stability? That is ultimately what concerns fixed income investors and hence a reversal of the plan to cut the food tax and signs of a more active BoJ in hiking rates could ultimately help ease super-long JGB risks. Yen appreciation would also help ease inflation risks and help provide support and the intervention rhetoric in January helped. The JGB auctions that took place in January were also indicative of better investor appetite at these higher yields. There remains a plausible scenario in which the LDP does worse than expected in the election and then the LDP opposes plans for a suspension of the sales tax on food. The BoJ could also hike by April which would help ease fears over being behind the curve and see more modest yield rises.

NIKKEI/TV TOKYO POLLS (JAN-26 – PRESENT)

Source: Nikkei & MUFG GMR

MONTHLY CHANGES IN 20YR JGB YIELD (Z-SCORE)

Source: Bloomberg, Macrobond & MUFG GMR

Euro

MARKET UPDATE

In January the euro strengthened notably further against the US dollar in terms of London closing rates from 1.1756 to 1.1881. The ECB did not meet in January and hence the deposit rate was unchanged at 2.00% - the level reached following 100bps of cuts last year. The cumulative easing amounted to 200bps over 2024-25. QT will continue this year with the ECB’s projected maturities from both APP and PEPP expected to result in a EUR 500bn reduction in balance sheet holdings.

OUTLOOK

The euro advance in 2025 has extended into 2026 with EUR/USD briefly breaking above the 1.2000-level for the first time since June 2021. There were no specific euro developments in January but US dollar sentiment deteriorated further and the dollar debasement trade intensified. After advancing by 65% in 2025, gold gained incredibly by 14% in January. Trump-related uncertainties in the areas of geopolitics and trade fuelled the selling that was then reinforced by the Federal Reserve ‘checking rates’ in USD/JPY and the comment by Trump that the dollar weakness was “great”.

One important uncertainty for 2026 is how quickly the EUR 1 trillion fiscal spending program on infrastructure and defence in Germany will kick in to lift economic activity. The data in January suggests that the impact could come quite quickly. German factory orders surged 5.6% MoM in November after a 1.6% gain in October. The annual rate now stands at 10.5%, the biggest gain since May 2011 when the covid period is excluded. That is set to boost industrial production over the coming months and help lift GDP growth. Real GDP growth is expected to accelerate from just 0.2% in 2025 to 1.0% this year. The Greenland threat from President Trump is a wake-up call for Europe and we see increased defence spending in other countries over the coming years. Sovereign balance sheet capacity is limited but increased central issuance via the EU bond market under programs like SAFE and the EDM (European Defence Mechanism) will likely be utilised to speed up spending.

The continued gradual expansion of EU bonds in issuance (around EUR 650bn currently) will over time prove a positive in growing the pool of High Quality Liquid Assets that reserve managers seek. But even prior to that (liquidity is still poor but improving) reserve managers dealing with US dollar debasement risks will likely view the euro more favourably going forward. The EUR composition jumped last year (valuation was key but central banks also bought into a rising EUR) and central banks are looking at the euro more favourably. The surge in gold is looking more like a bubble that will likely see reserve management demand shift elsewhere in 2026.

We have only tweaked our year-end forecast (from 1.2400) as we already had a EUR bullish forecast and the global macro backdrop remains favourable for EUR strength. We certainly don’t discount the risk of a Trump-related sharp dollar sell-off that could mean a year-end level of closer to 1.3000 is realised.

INTEREST RATE OUTLOOK

* Interest rate assumptions incorporated into MUFG foreign exchange forecasts.

After jumping by 49bps in 2025, the 10-year German bund yield hit a closing high of 2.91% in January before retracing to close down 2bps at 2.84%. Signs of better data in Germany helped to lift yields initially while global risks remained strong and the surge in metal, crude and natural gas prices all helped to lift longer-term yields. But yields were also capped by FX developments and the break above the 1.2000-level for EUR/USD helped curtail upward momentum in yields. Fears over an attack on Iran by the US has also helped lift energy prices although there are risks both ways in regard to Iran. A fall of the regime would certainly lead to increased crude oil supply over time. We continue to see greater downside risks for the ECB policy rate given the stronger EUR, slowing wage growth and lower prices on the back of excess supply. The threat of tariffs on exports to the US (since retracted) also led some ECB officials to signal the potential for renewed cuts, underlining the current monetary policy bias. Given our risk bias and forecasts for lower UST bond yields, we expect the 10-year German bund yield to drift lower this year.

GERMAN INDUSTRIAL PRODUCTION & NEW ORDERS

Source: : Bloomberg, Macrobond & MUFG GMR

EURO EFFECTIVE EXCHANGE RATE

Source:: Bloomberg, Macrobond & MUFG GMR

Pound Sterling

MARKET UPDATE

In January the pound advanced versus the dollar in terms of London closing rates, moving from 1.3468 to 1.3719. In addition, the pound advanced against the euro from 0.8729 to 0.8660. The MPC did not meet in January and hence the key policy rate was unchanged at 3.75%, after six 25bp cuts since August 2024.

OUTLOOK

Like all G10 currencies in January, the pound advanced versus the US dollar after sharp falls fuelled by US dollar debasement fears and general concerns over unpredictable policies from the Trump administration. The pound performance versus other G10 currencies was basically mid-table. The pound did benefit from receding expectations of rate cuts from the BoE. In part this reflected better GDP data (Nov 0.3% MoM vs 0.1% exp), headline wage growth coming in a little stronger and headline CPI also coming in 0.1ppt higher than expected at 3.4%. We now expect 0.2% QoQ GDP in Q4, a decent outcome given all the budget uncertainty that prevailed at the time. But the labour demand picture remains poor with the PAYE jobs data showing a 43k drop in employment, the largest drop since covid. Job losses have now been recorded for four consecutive months and will ensure downward pressure on wage growth. Private earnings ex-bonus YoY did slow to 3.6%, still too high but approaching levels more consistent with price stability. The pre-covid long-term average is 2.8%. There are two CPI and job reports before the March MPC meeting so there remains the potential for a surprise cut (only 5bps priced). But it is more likely now that we get the next cut in May followed by one further cut in August taking the policy rate to 3.25%.

The refusal of the NEC of the Labour party to grant Andy Burnham permission to step down as mayor of Manchester and run for parliament in an upcoming by-election has refocused investor minds on the potential of PM Keir Starmer facing a leadership challenge. Labour will likely lose that by-election to Reform and then Labour is expected to perform poorly in local elections in May. That may well encourage other sitting MPs to challenge Starmer. 20% of sitting MPs are required to vote in favour of a challenge. This scenario remains a close call. Fiscal risks have receded notably and the Gilt market has outperformed. MPs will be aware of the risk of destabilising markets again, which could act as a deterrent. Still, a challenge would certainly lift expectations of a shift to the left and prompt renewed instability in Gilts that would see the pound suffer. That is the primary risk for the pound this year and is reflected in our forecast for EUR/GBP to move higher. Pound volatility could pick-up in Q2.

The OIS curve is under-priced for BoE action this year and the potential political uncertainties that lie ahead indicate the potential for GBP underperformance. GBP/USD is still set to rise given our US dollar bearish view, but the GBP is set to underperform other G10 currencies including the euro.

INTEREST RATE OUTLOOK

* Interest rate assumptions incorporated into MUFG foreign exchange forecasts.

After declining by 9bps in 2025, the 10-year Gilt yield increased modestly in January, by 3bps to close at 4.51%. The rise was more modest than the rise in the 10-year UST bond yield with sentiment in the Gilt market generally more favourable following the Autumn budget last November. A notable decline in inflation in Q4 last year has also eased inflation risks following years of Gilt market underperformance due to sticky inflation and wage growth. Our view for 2026 is that the 10-year Gilt yield can decline modestly – inflation should drop further this year, especially in April on an energy base effect that should then see the headline annual CPI rate a lot closer to the 2.0% target. That alone should increase confidence within the MPC on achieving the goal and hence delivering further rate cuts. The key risk relates to politics and the potential for renewed political instability and fears of further fiscal slippage. One further risk could be the US Treasury market. The selection of Kevin Warsh may mean Fed balance sheet shrinkage unfolds and lifts longer-term yields in the US that may act to limit the scale of decline in Gilt yields. The timing of that risk is unclear though and for now we assume Gilt yields can decline modestly.

UK GDP QOQ, %

Source: : Bloomberg, Macrobond & MUFG GMR

EUR/GBP VS. 200-DAY MOVING AVERAGE

Source: : Bloomberg, Macrobond & MUFG GMR

Chinese renminbi

MARKET UPDATE

In January, USD/CNY moved from 6.9876 to 6.9520. On 15th January, the PBoC announced a 25bps cut to various structural monetary policy tools which effectively lowered the 1-year relending rate from 1.5% to 1.25%. Meanwhile, the PBoC also announced an increase relending quota for agriculture and small business (+RMB 500bn, which helped to establish the RMB 1tn relending facilities for private enterprises); sci-tech innovation and technical transformation (+RMB 400bn).  

OUTLOOK

China has managed to achieve the 5% growth target for 2025 despite Q4 growth slowed to 4.5%yoy from 4.8%yoy previously. The growth slowdown was caused by weaker consumption and investment whereas net exports were even stronger in the quarter, contributing 1.4ppts to the headline Q4 growth. The GDP deflator remained negative for 11th consecutive quarters in Q4 at -0.7% despite narrowing from -1.1% previously. While the key challenges such as entrenched deflation, weak job prospects and housing downturn will largely remain in 2026, there were bright spots in the economy however with exports and IP achieving similar growth in 2025 compared to 2024 (exports: 5.5% vs 5.9%, IP: 5.9% vs 5.8%). In particular, high-tech manufacturing IP growth accelerated from 8.9% to 9.4%.

Policy wise, the government has introduced multiple policies in December-January period. For instance, the MoF and other departments jointly announced incremental measures on 20 January to extend fiscal subsidies program (personal consumption, services sector business and equipment upgrade loans) until the end of 2026 and expanded program scopes and removed certain restrictions. It also set up a new fiscal subsidy program and special guarantee program for micro, small and medium-sized private enterprises. These fiscal subsidies and lowering of relending rate will lower borrowing cost for both corporates (loan subsidy) and banks (relending), creating new investment in industrial, tech and services sectors. Separately, the NDRC has dispatched the first tranche of fund worth RMB 93.6 bn from ultra-long special CGB to support equipment upgrades.

Then CNY appreciation trend remained firmly intact helped by the lower PBoC USD/CNY fixing over the month. Notably, USD/CNY fixing dipped below the 7.0000 level for the first time since May 2023, signalling PBoC willingness to allow the appreciation of CNY but at a modest pace. We can observe the PBoC’s intention of maintaining a “modest appreciation” in the gap between the market surveyed fixing level and the actual PBoC fixing level, which has been negative and averaged at -352pips in the month. Looking ahead, we remain positive on CNY as growth is likely to improve further trend-wise this year from last quarter’s cyclical trough to achieve a full year growth similar to 2025. In addition to a weaker US dollar, we think the ongoing investment theme related to rising capability of China tech will attract foreign portfolio inflow too, lending support for CNY.

INTEREST RATE OUTLOOK

* Interest rate assumptions incorporated into MUFG foreign exchange forecasts.

Contrasting with last year’s monetary easing in May, the announcement of 25bps cut to structural monetary policy tools in January did not come together with the 10bps rate cut on the policy rate (7-day reverse repo rate) or a 50bps RRR cut. While this sent a clear signal of a targeted-approach towards monetary easing, the PBoC vice governor Zou Lan mentioned there is still space for cuts this year given a relatively stable RMB, a US dollar that’s in a rate-cutting cycle and stabilized domestic bank’s net interest margin. We think the cuts will be dependent on the implementation of the existing and incremental measures just announced. If the downward pressure on growth intensifies in January and February, a cut as soon as March cannot be ruled out (we expect 10bps cut in Q1, and another 20bps in Q2). In the month, 10-year CGB yield was down by 4bps to 1.81% partly reflecting market expectations of further easing in the year. With bond supply pressure likely to remain elevated in 1H due to government front-loading, economic growth likely to pick up later this year and a gradual reflation, we think it will offset the downward pressure from monetary easing and expect a modest increase in 10-year CGB yield to 2.0% by Q4 2026.

PBOC USD/CNY FIXING DIPPED BELOW 7.0000 LEVEL IN LATE JANUARY

Source: : Bloomberg, MUFG GMR

10Y CGB YIELD DROPPED BY 4BPS TO 1.81% IN JANUARY

Source: : Bloomberg, MUFG GMR

For other currencies outlooks, please download the PDF version attached at the top of this page.