Foreign Exchange Commentary

Summary

• Canadian dollar flat after trade agreement with China.
• U.S. December consumer prices rose 0.3% MoM / 2.7% YoY both matching forecasts, however, core of 2.6% was below 2.7% estimate.
• U.S. trade deficit was better than expectations.
• Japan’s yen sentiment so bad, current account surplus is not helping as yen falls to near 159 -- its weakest level since July 2024.
• Japanese sell largest amount of sovereign bonds since 2011; Japan 20, 30-year bonds fall of early week snap election announcements.
• U.S. Treasury yield remains above 4.10% on the benchmark 10-year bond yield, currently at 4.19%.
• U.S, producer prices rose a bit more than forecast at 3.0% vs. 2.7% YoY, however core rate was flat vs. 0.2% hike expected.
• Mexico peso gives back a small portion of sharp gains this week.
• British pound sterling retreats during week.
• U.S. November retail sales rose 0.6%.
• U.S. jobless claims at 198,000 in week ended January 10 vs. 215,000 estimate. 
• China’s yuan headed for eighth week of gains. 

Noteworthy

• Japanese Yen Trims Weekly Drop Following Verbal Intervention
• Thus Far, It’s One of the Quietest Januarys on Record for FX Volatility

The major move in currency markets this week was the significant loss of value of the Japanese yen as it fell to near 159 per one U.S. dollar – its weakest level since July 2024.

Japanese authorities might show some reservation to follow through on threats for yen interventions before the Bank of Japan’s January 23 policy decision, MUFG Bank said in a note. Bank of Japan (BoJ) Governor Kazuo Ueda is likely to maintain a cautious stance on raising interest rates further. 

This caution is one factor that risks the failure of potential interventions to shore up the yen. Other factors include Prime Minister Sanae Takaichi’s plans for a snap election and Federal Reserve officials signaling a pause in rate cuts.  

If the BoJ shows a clearer opposition to yen depreciation and signals an earlier rate rise, interventions could prove more successful. 

Today, the yen strengthened against other G-10 and Asian currencies after Japanese Finance Minister Katayama said Friday that the government is ready to take action against any excessive yen movements, as the currency weakens toward levels that may trigger intervention. 

However, “intervention risks would be more pronounced if JPY volatility remains elevated, which could necessitate action by the Japanese authorities to preserve credibility,” DBS Group Research’s Chang Wei Liang said, before Katayama’s latest remarks. 

"Given the elevated political uncertainty and possible policy shifts, JPY weakness could linger for now,” the FX & credit strategist said in commentary. USD/JPY is down 0.35% at 158.05, LSEG data show.

Elsewhere, the U.S. dollar looks set to depreciate against most currencies this year as lower U.S. interest rates make it cheaper to take protection against the risk of the currency weakening, Bank of America analysts said in a note. 

With U.S. interest rate differentials set to narrow further as the Federal Reserve cuts rates, the costs of hedging U.S. assets against a weaker dollar will also fall, they say. “We see still relatively high hedging costs as one of the key hurdles that may have prevented follow-through of hedging activity (of dollar exposures) in 2025.” 

The Trump administration’s push to lower housing related costs could encourage further rate cuts, they say. Federal Reserve independence risks also pose a potential dollar headwind.

Meanwhile, the British pound sterling is likely to strengthen this year as long-term U.K. government yields fall on reduced fiscal concerns since November’s U.K. budget, Bank of America analysts say in a note. 

Rising term premium, the extra compensation investors demand for holding long-term gilts, was the “Achilles Heel” for sterling in 2025 as markets become more sensitive to fiscal risks, they say. 

Term premium has fallen since the budget and in turn propelled sterling higher. Sterling could receive further support if the U.K improves relations with the EU as this would remove some of the structural headwinds to the economy.  

Thursday’s better-than-expected economic growth data for November provide a positive sign for sterling even if the economy continues to face challenges, Commerzbank said in a note.  

The data showed the economy grew 0.3% in November. Despite concerns about fiscal tightening in the November budget, the economy recorded solid growth, Commerzbank says. 

Worries about a recession and more significant interest-rate cuts were therefore probably premature, he says. “But it is also clear that monthly growth figures are just one data release.” Labor market and inflation figures are due next week with the latter particularly decisive for sterling’s performance in coming weeks.

The euro currency is being favored as a funding currency in carry trades, where investors borrow in low interest-rate currencies to invest in higher-yielding ones, ING Bank said in a note. 

The euro looks range-bound versus the dollar and one-month implied volatility for the exchange rate—a measure of expected price swings—continues to languish near 5%, LSEG data show. This encourages investors to fund carry trades out of the euro to invest in higher-yielding emerging-market currencies, ING Bank said.  

The euro currency could be considered less risky than funding out of the yen, where one-month dollar-yen implied volatility is 8.5% and the Bank of Japan could use interventions to shore up its currency.

Finally, fears of the dollar losing its dominance look overdone as there is little evidence of de-dollarization, Payden & Rygel economist Jeffrey Cleveland says in a note. “Foreign demand for U.S. assets— including Treasurys, corporates, and equities—remains strong,” he says. 

The dollar’s movements have been driven largely by shifting interest-rate and growth expectations as opposed to foreign selling or a collapse in confidence, he says. As long as U.S. productivity growth remains strong, the case for U.S. exceptionalism remains intact, he says. The DXY dollar index trades flat at 99.29.