Nowhere to Hide in FX

The greenback bounced back after steep losses in January. But it’s trading poorly, in our view.

US data has largely beat expectations this year, forcing many economists to upgrade their GDP forecasts. The Fed’s messaging has shifted noticeably, with even outliers like Stephen Miran sounding less dovish. A US strike on Iran looks imminent, at least according to betting markets, which could send oil prices higher. Under normal circumstances, this combination should have significantly boosted the US dollar. Instead, the market is trading a different story.

A big part of the pressure is coming from the equity side. High-frequency flow data shows investors have been piling into non‑US stocks as they rotate out of crowded US tech positions. In addition, policy chaos out of Washington continues to erode credibility. Some asset manager surveys, as well as the CFTC’s Commitments of Traders report, show that net shorts against the greenback have risen to a four-year high.

Is USD bearishness becoming too consensus? No. The market is still unwinding the structural long USD position that formed over several years on the back of superior US yields, tech leadership and the dollar’s safe haven status.

The main challenge for USD bears is that few other currencies look appealing. The euro, pound and Canadian dollar will all have lower rates than the US and lacklustre economic growth for at least the next couple of years. The yen incurs punitive negative real rates. And the yuan is heavily managed. This doesn’t mean the USD can’t fall. It just means investors will have to accept imperfect substitutes, which will, ironically, sow the seeds of future volatility.

We maintain our forecast for a weaker USD vs. most currencies in 2026.

The eurozone outlook remains one of muddle through with downside fiscal and political risks.

GDP growth is tracking in a modest 1.0–1.5% range across most nowcasts. The unemployment rate has held near 6.2%, very low by European standards. But the labour market picture is uneven, with Italy and Spain posting firmer job gains while France and Germany continue to soften.

Euro area CPI fell to 1.7% y/y in January, though we expect it to firm back to 2% in the coming months. The ECB has signalled that its easing cycle is over and that the central bank is firmly on hold. Some of the hawkish members of the Governing Council are even guiding towards hikes.

We remain unconvinced. In fact, we have pencilled in a cut by mid-year. With inflation back inside the target band and growth still lacklustre, we think the balance of risks is tilted toward further downside if any new deflationary shocks hit. For instance, if EURUSD strengthened above 1.22, we would be more confident in that call.

Against that backdrop, we believe the euro is overvalued. It has borne the brunt of USD selling thanks to deep liquidity and limited pushback from the ECB. We expect the single currency will trade within a broad 1.15 to 1.20 range against the US dollar this year, as the burden of USD weakness shifts to Asian and commodity currencies.

We continue to expect a broad range in EURUSD between 1.15 and 1.20 in 2026.

The UK remains perhaps the most fiscally constrained major economy. The Labour government’s plans to rein in the deficit and boost growth have little credibility with the market. And a fresh political scandal has only deepened Prime Minister Starmer’s troubles. Will he resign? It will come down to the nationwide local elections scheduled for May 7, where Labour is poised for heavy losses.

Meanwhile, jobs have been lost for five consecutive months and the unemployment rate has pushed up to 5.2%, the highest since Covid. The Bank of England is expected to lower rates at its next policy meeting on March 19, and we expect at least one more cut by July.

As a result, we see the pound as having the most challenging macro mix in the G7: a softening labour market, stubborn inflation and a backdrop of fiscal vulnerability and political uncertainty. With the Bank of England poised to cut rates further, we expect sterling to remain the weakest link among major currencies.

We have dropped our 2026 forecast for the GBP to 1.30 vs. USD (from 1.34) and to 0.92 vs. EUR (from 0.90).

As we flagged last month, authorities were finally forced to intervene to halt the excessive slide in the yen. The Federal Reserve Bank of New York, acting for the US Treasury, conducted a “rate check” on USDJPY on January 24. US officials have not confirmed if this was done at the request of Japan, but it is likely that there was at least an understanding between the two allies that the yen was overshooting and needed a circuit breaker.

Intervention on its own will not stabilize the yen. The currency’s two-year slide reflects a combination of aggressive fiscal expansion and deeply negative real policy rates. The former is set to continue, as underscored in Prime Minister Takaichi’s post-election policy speech on February 20. That leaves the burden squarely on the Bank of Japan.

The Bank raised its benchmark rate to 0.75% in December, and some members of the MPC have signalled that rate hikes will continue at a very measured pace. Markets are pricing the next hike in June, followed by another in December. This is far below any orthodox prescription, particularly since inflation is above target and wage growth is hitting record highs.

Despite all this, we remain bullish on the yen. The currency has weakened far more than levels justified by rate spreads. And now that the LDP has secured a solid parliamentary majority, the BoJ could be allowed to operate a bit more freely. More important, the yen carry trade has become very crowded. And ex-ante real yields on JGBs (nominal bond yield minus breakeven inflation) have surged to their highest level in at least 10 years. This could spur some Japanese asset managers to repatriate.

We maintain our USDJPY forecast of 150 by year-end and 140 next year.

We remain bullish on the CNY. In recent notes, we argued that China will tolerate a substantial appreciation of its currency. Indeed, USDCNY has fallen by 3% since December—a sizable move for the low beta pair. In our view, this trend still has plenty of runway.

The story is relatively simple. China’s trade surplus is surging despite American tariffs thanks to the competitiveness of Chinese manufacturing, especially in cars and batteries. Moreover, China is deepening ties with the Global South, where it is positioning itself as the more open trade partner.

Last week, China announced a sweeping removal of import tariffs on goods from 53 African countries, effective May 2026. Beijing framed the change as part of a deeper, long-term economic partnership with the continent. But strategically, it also pulls Africa closer into China’s orbit, which could leave the US dollar facing more structural competition.

Finally, Beijing appears comfortable with a gradual appreciation as it reinforces the “anti‑involution” message to exporters: the future lies in higher-value production, not price-driven competition.

We forecast USDCNY to fall to 6.70 by the end of this year and 6.50 next year.