USD: Policy risk trumps fundamentals

The dollar has started the week on the back foot again, with markets increasingly focused on the risk of Japanese and US coordination to underpin the yen. Last week’s US-linked “rate check” has been taken as a signal that Washington is at least tolerant of a weaker dollar, which helped accelerate Monday’s move. The sell-off is no longer a narrow EUR story. It has spread across Asia and the wider G10, lifting GBP, AUD and NZD as investors rotate away from USD exposure.

Rate checks are typically a soft warning shot: officials canvas major banks on price action and market functioning before escalating to more direct steps. Japan uses the tool routinely, but any hint of US involvement materially raises the signal value. The most plausible explanation is concern that yen depreciation amplified volatility in Japanese government bonds, pushing global yields higher and tightening financial conditions more broadly.

A coordinated, Plaza-style effort to drive JPY stronger over time remains a tail risk, but it would be a regime-level shift for FX if it gained traction. For now, the immediate impact has been via volatility: higher implieds are eroding the appeal of yen-funded carry, even though there is still little evidence of a meaningful unwind. If carry begins to reverse in size, the next phase could be sharper and more disorderly across high-yield FX.

What makes this move notable is the disconnect with the underlying macro. US data surprises remain relatively firm and the front-end US yield advantage has widened versus G7 peers, yet USD is falling. That pattern echoes the tariff-driven stress episodes where policy risk overwhelmed rate differentials. Those fundamentals may still limit how far USD can slide, particularly into Wednesday’s Fed decision, where the debate is less about an immediate cut and more about the duration of the pause and the cohesion of the Committee behind Chair Powell.

EUR: Higher levels look more like USD weakness than euro strength

EUR/USD continued to grind higher, briefly testing the 1.19 area before easing back towards the high-1.18s. The pair is now within touching distance of last year’s peak near 1.1919. Unlike the prior run-up, which was underpinned by a clear Fed dovish repricing, the latest leg looks predominantly USD-led, which makes the durability of these levels more questionable.

Euro area data offered little independent support. Germany’s Ifo business climate index was unchanged at 87.6 in January and missed expectations, underscoring how entrenched weak sentiment remains. The divergence between more hopeful expectations and softer current conditions still points to a slow translation from spending plans into real activity. For FX, however, the euro’s domestic backdrop continues to matter less than the dollar narrative, given its limited influence on the ECB’s near-term reaction function.

GBP: Sterling supported by rates repricing, but momentum looks stretched

Sterling is trading near multi-month highs versus both the dollar and the euro, with the USD leg doing much of the work in GBP/USD. Locally, UK inflation risks are back in focus, helping underpin the front end of the UK rates curve and lending the pound a fundamental tailwind.

The latest BRC shop price data showed a clear step-up in annual price inflation in January, reinforcing the message from recent surveys that disinflation may not be smooth. PMI pricing signals have also firmed, pointing to persistent cost pressure and higher selling prices. The implication is straightforward: the Bank of England has less room to ease aggressively if inflation threatens to re-accelerate, and that reduces the downside risk priced into UK rates relative to last year.

Technically, GBP/USD remains well supported above key moving averages, but short-term momentum indicators look stretched, suggesting the risk of consolidation or a pullback if USD stabilises around the Fed. In GBP/EUR, the recovery has momentum, but the area around the 200-day average near 1.156 has capped rallies repeatedly, leaving that level as the near-term hurdle for a cleaner breakout.

Looking ahead

• Fed decision (Wednesday): focus on guidance around the length of the pause and the degree of unity behind Powell.

• USD/JPY watch: any escalation in official rhetoric or further “market checking” will keep yen-vol and broader USD sentiment in play.

• Carry risk: signs of a genuine unwind would raise the probability of a sharper, cross-asset volatility pulse.

• UK inflation pipeline: upcoming CPI and wage signals will determine whether the recent sterling support from rates repricing can hold.

• EUR/USD levels: 1.19 remains a key area; sustainability likely requires more than just USD softness.