February 2026 Monthly

The revival of the Roosevelt Corollary to the Monroe Doctrine under President Trump's "Donroe Doctrine" marks a turning point in U.S. foreign policy. Washington reportedly carried out hundreds of airstrikes across seven countries in 2025, from Yemen to Nigeria. The new year began with forcibly removal of Venezuela's strongman Maduro and threatening to take Greenland "the easy way or the hard way." The US continues to threaten Iran and vows more action against Cuba. The message is straightforward: spheres of influence are not constraints on power; they are how power is exercised.

The US toned down its rhetoric, agreed not to use force to acquire Greenland, and rescinded the tariff threats on several European countries who were opposed. But still the damage was done. Perhaps not in a way that can be immediately measured, but trust among the US closest allies seems to be irreparably harmed. Reports circulated in January that the Trump administration was talking to Alberta officials trying to foster a break. Canada's Prime Minister Carney made this explicitly clear in Davos and struck a responsive chord that previous order has ruptured. 

In a matter of four sessions in late January, the US roiled the foreign exchange market: The US Treasury Department, through the Federal Reserve seemed to offer a type of verbal intervention to weaken the US dollar; the president said the "dollar was great" and that he was not concerned while it was experiencing a dramatic slide; and then Treasury Secretary Bessent told a CNBC audience that the US always favors a strong dollar. This is grist for the market's mill that has concluded that between seeking sharply lower rates and efforts to boost the exports and is consistent with pre-election talk of a new Plaza-like accord. 

Still, the dollar sell-off stretched the technical indicators, and news that former Federal Reserve Governor Kevin Warsh would be nominated to replace Chair Powell at the helm of the central bank helped trigger an upside correction in the dollar. It looks set to carry into early February, though we are doubtful that administration will succeed its demand for sharply lower interest rates. The December "Summary of Economic Projections" showed median projection of a very divided Fed for one rate cut in 2026. The Fed funds futures have two cuts discounted. At the end of 2025, the pricing was consistent with about a 1-in-3 chance of a third cut.

EC Trade Deals

While the U.S. leans on military force, Europe quietly wields economic power. After twenty-five years of negotiations, the EU approved the Mercosur trade deal in January, creating a free trade bloc of roughly 700 million people, now pending approval by the European parliament. A new trade deal has been negotiated with India, and a rapprochement has been reached with China. Europe is de-risking from the US. 

In mid-January, the EU and China agreed on a framework for electric vehicle imports, replacing punitive tariffs with minimum price commitments. After imposing duties in the mid-30s on Chinese EVs in 2024, Brussels chose managed competition over trade war. Chinese EV exports to Europe surged in 2025, and BYD's Hungarian factory will soon produce vehicles entirely inside the single market, embedding Chinese firms within Europe's industrial base.

Europe's strategy reflects a hard lesson: in a world shaped by U.S. tariffs and Chinese industrial policy, the EU needs its own supply chains and markets. Trade talks with others, including Indonesia and Mexico underscore a bloc determined not to be squeezed between Washington and Beijing. The irony is stark—Trump's unilateralism has accelerated the multipolar trade system the administration publicly rejects.

Tough Straits for Japan

Japan navigates its own bind. Prime Minister Sanae Takaichi, buoyed by strong approval ratings, is preparing a snap February election to solidify a fragile majority. The bet is risky, compressing the budget timeline and limiting opportunities to engage Trump before his expected China visit. Yet domestic pressures leave little choice. The yen is weak, inflation has run above target for nearly four years, and tensions with China over Taipei has seen Beijing’s typical economic retaliation.

The Bank of Japan is equally trapped. Markets expect modest rate hikes in 2026, even as growth remains fragile. The yen's slide toward 160 per dollar risks reigniting import-led inflation, yet aggressive tightening threatens domestic demand. Rather than political pressure behind the BOJ's slow walking of raising rate, the fragile economy, soft labor earnings, and moderating price pressures are the more crucial considerations. 

The Dollar

This pause comes at an uncomfortable juncture. Geopolitical risk is elevated, growth signals are mixed, and fiscal policy has overtaken monetary policy as the primary macro driver. Central banks are no longer steering outcomes; they are reacting to them. The familiar playbook offers little guidance when both inflation and weakness coexist.

The unintended casualty of this paralysis is the U.S. dollar. In theory, a world short on conviction should favor the reserve currency. In practice, it has not. The Dollar Index is near 97, around 11.5% below its 2025 highs. We have suggested potential into the 88.00-90.00 area this year. With the Fed boxed in and real yields drifting lower, the dollar has lost its policy premium. Fiscal noise and political pressure on the Fed accelerate that erosion.

Yet dollar weakness is not a clean release valve. For Europe and Japan, it offers temporary competitiveness relief while complicating inflation dynamics. For emerging markets, cheaper dollar funding eases balance sheet stress but leaves them exposed to abrupt reversals. For the U.S., any export benefit arrives alongside higher import prices, reinforcing the very inflation pressures policymakers are resisting.

Q1 2026 is therefore less about anticipation than acceptance. Central banks are on hold not because conditions are benign, but because the margin for error is thin. Europe and Canada are securing trade relationships to reduce vulnerability to U.S. and Chinese shocks. Japan searches for political durability and a credible exit from ultra-easy policy. Washington equates activity with strategy abroad even as policy coherence frays at home. Markets have adapted to this uneasy equilibrium. The risk is not that something suddenly breaks, but that nothing does—and paralysis is mistaken for stability in a world that is anything but. 

Bannockburn World Currency Index 

Bannockburn's World Currency Index, a GDP-weighted basket of the currencies of the dozen largest economies, rose the third consecutive month. The nearly 1.10% gain in January is its best monthly performance since last April. The gain was roughly the equivalent of the appreciation in November and December combined. 

All of the G10 components rose against the dollar in January. The euro was the weakest with about a 1.3% gain. The Australian dollar was the strongest, rising by nearly 5.25%. Verbal intervention by Japanese officials, and arguably the US Treasury helped reverse the yen's losses that prevailed until the last week of January. The powerful short squeeze lifted the yen by nearly 1.4% for the month as a whole. 

Most emerging market currencies in Bannockburn's World Currency Index also rose in January. There were two exceptions. The Indian rupee, which fell by 2.3%, despite central bank intervention, and the South Korean won that slipped by almost 0.40%. The won's loss happened on the last day of the month. Despite the persistently lower dollar fixes, the Chinese yuan rose by a minor 0.5%. The Brazilian real was the strongest, rising 4.6%, followed by Mexican peso (3.85%) and the Russian ruble (3.50%). 

Bannockburn's World Currency Index reached its best level since September 2024 in late January. At the end of last year, we projected potential toward 94.75-96.00 this year, a roughly 5-7% gain reflecting our bearish US dollar view. That still seems broadly fair. 

U.S. Dollar:  The Dollar Index fell for the third consecutive month. Its recovery from around Christmas stalled in mid-January as the US threatened military force to take Greenland and levy new tariffs on several European countries who vocally objected. The US retracted its threats, but the damage was done. However, what appears to have been a type of verbal intervention to support the yen and President Trump's lack of concern about the dollar as it was being trounced, while reiterating his call for lower US interest rates, played on widespread ideas that the administration seeks a weaker dollar. A lower dollar would ostensibly help exports and ease financial conditions. Treasury Secretary Bessent's claim that the US always supports a strong dollar does not seem particularly convincing. Even with a new chair at the Fed (in May), the administration faces an uphill battle to convince the FOMC to support aggressive rate cuts. The futures market has almost 90% of a cut discounted for the end of H1 26. At the end of last year, not only one cut was discounted but about 35% of a second cut in the first half was priced into the market. Meanwhile, the Supreme Court has yet to hand down its verdict on the legality of the US tariffs imposed under emergency powers. A decision is possible in late February. Judging from the question the justices asked, it seems that the court is skeptical of the president power to fire Federal Reserve governor, but rather than tule on that, it may send it back to a lower court to determine if Governor Cook was given due process. 

Euro: The euro trended lower in the first half of January, retracing the lion's share of the rally that began in late November. The euro (and most of the G10 currencies) began recovering as tensions rose over the US desire to acquire Greenland. The US threatened tariffs on several European countries that were opposed. The euro's recovery accelerated even after the US backed down from its threat to use force and rescinded its tariff threat. The euro also rose as the US was seen aiding Japan's verbal efforts to arrest the yen's declines. Comments from President Trump a couple of days later expressing no concern for foreign exchange developments played on market ideas that the US administration welcomes a weaker dollar. It is consistent with efforts to boost US exports and ease monetary conditions in the face of a Fed that is reluctant to ease as far or as fast as the president desires. The euro spiked to around $1.2080 after Trump's comments. The strength of the euro spurred one ECB official into warning that the central bank may have to cut rates to stem the euro's appreciation. The swaps market took little notice and is not pricing in more than around 25% chance of a cut this year. In the last monthly note, we suggested the euro had scope toward $1.2260-$1.2350, and possibly $1.25 this year. This was more bullish than consensus, and it still seems reasonable. Yet, in the near-term, we look for the euro to consolidate and correct lower. 

(As of January 30, indicative closing prices, previous in parentheses) 

Spot: $1.1850 ($1.1750) Median Bloomberg One-month forecast: $1.1827 ($1.1750) One-month forward: $1.1867 ($1.1735) One-month implied vol: 7.3% (5.3%)

Japanese Yen:  The yen bears were not dissuaded by the Bank of Japan's December rate hike or escalated verbal intervention by Japanese officials. The dollar was still threatening JPY159 when the NY Federal Reserve checked rates on January 23, and reports suggest it made it clear that the check was on behalf of the Treasury Department unlike the more regular checks it conducts. This sets the proverbial cat among the pigeons. Apparently without spending a penny, the verbal intervention succeeded in breaking the one-way yen weakening trend. In a powerful short squeeze, it triggered more than a 4% gain in the yen in three sessions. The dollar was sold to almost JPY152, which overshot the halfway mark of the greenback's gains since the September 17 Fed rate cut. We look for an extension of the dollar's recovery in early February and suspect there may be potential toward JPY155.50-JPY156.50. The dilemma for Japanese policymakers remains and the market is aware of it: Can officials arrest the meltdown in Japanese government bonds and stop the yen from sliding? We had anticipated an election this year to give Prime Minister Takaichi a public mandate after becoming the head of the Liberal Democratic Party. However, rather than near midyear, as we thought likely, it is now scheduled for February 8. Her pledge to lift the sales tax on food for two years may have disrupted the bond market but she likely boosted her chances of the LDP doing well in election. Meanwhile, the swaps market has two hikes this year fully discounted, a little more confident than at the end of last year. 

Spot: JPY154.80 (JPY156.85) Median Bloomberg One-month forecast: JPY154.40 (JPY155.05) One-month forward: JPY154.40 (JPY156.40). One-month implied vol: 9.9% (8.1%)

British Pound: Sterling rose by about 1.8% in January, which mostly reflected the broad-based weakness of the dollar rather than positive UK developments. It reached nearly $1.38, its highest level since October 2021. The sharp rally has technical indicators over-extended. At 3.4%, the UK has the highest inflation among the G10. Growth, on the other hand, around 0.1% in Q4 25 may be among the weakest. The Bank of England is caught between the two, and after a rate cut at the end of 2025, it appears to be in no hurry to cut rates this year. The swaps market has about a 20% of a cut discounted for Q1. It rises to around 95% by the end of the second quarter. With Manchester Mayor Burnham blocked from running for an open MP position, Prime Minister Starmer appears to have put down a threat from the left-wing of Labour. A poor showing in the May local elections would likely reinvigorate opposition within the party. Last month, we suggested sterling may have potential into the $1.4000-$1.4250 area this year. This still seems reasonable but consolidative/corrective phase that appears to have begun could see $1.3550-$1.3650. 

Spot: $1.38655 ($1.3455) Median Bloomberg One-month forecast: $1.3600 ($1.3415) One-month forward: $1.3685 ($1.3460) One-month implied vol: 7.3% (5.9%)

Canadian Dollar: The Canadian dollar weakened in the first half of January and recovered fully in the second half of the month before consolidating. The greenback finished last year near CAD1.3725 and reached about CAD1.3930 near mid-month before falling to nearly CAD1.3480 on the last day in January. However, an upside recovery appears to have begun, and we suspect the US dollar can rise to the CAD1.3650-CAD1.3700 area. Prime Minister Carney's speech at Davos said there was a rupture in the world order. He is seeking to diversify trade, repair strained trade ties with China, and become more integrated with Europe, while spending more on defense and infrastructure. The displeasure the US has expressed with Canada risks adversely impacting the USMCA review, which President Trump negotiated in his first term. The Bank of Canada met in late January and kept the policy rate at 2.25%. The swaps market looks interest rates to be held steady this year. The Bank of Canada forecast 1.1% growth this year and 2.1% CPI, little changed from 2025. 

Spot: CAD1.3620 (CAD 1.3735) Median Bloomberg One-month forecast: CAD1.3800 (CAD1.3760) One-month forward: CAD1.3585 (CAD1.3715) One-month implied vol: 6.1% (4.6%)

Australian Dollar:  The Australian dollar is off to a strong start of 2026. The combination of better-than-expected data and hawkish comments by the top central bank officials encouraged speculation of a rate hike in early February. The derivatives market has another hike discounted for late this year. The Reserve Bank of Australia conducted a mini-easing cycle last year when the cash target rate was reduced by 75 bp in three steps to 3.60%. After appreciating 7.8% last year, the Australian dollar rose by about 4.8% in January. The Australian dollar reached its best level since Q1 23 and a recouped a little more than the half of the losses since the post-pandemic high in early 2021 near $0.8000. Australia's rare earths and processing, and broader exposure to commodities, appears to be helping facilitate cross border M&A activity. Our forecast for $0.7000-$0.7200 this year looks conservative. Still, initially, the dramatic gains have left the Australian dollar over-extended and after the February 3 central bank meeting, we anticipate a bout of profit-taking, which could extend toward $0.6880-$0.6900. 

Spot: $0.6965 ($0.6695) Median Bloomberg One-month forecast: $0.6700 ($0.6695) One-month forward: $0.6970 ($0.6700) One-month implied vol: 10.5% (7.6%). 

Mexican Peso:  The peso extended last year's nearly 15.7% rally in January. It rose by nearly 3.8% last month and saw its best level since June 2024. Part of the peso's strength reflects the attractiveness of the region with relatively high rates and commodity exposure. Three of the top four performing emerging market currencies in January were from Latam. Given the resilience of the peso (and Latam currencies more broadly) in the face of the sharp appreciation of traditional funding currencies, like the yen and Swiss franc, it suggests the preferred use of the dollar for carry-trades. The dollar forged a shelf near MXN17.10 at the end of January. While a significant dollar low does not appear to be in place, from a technical perspective, it is stretched. Corrective dollar gains may provide a place to buy cheaper pesos or reset hedges. We envision potential for the dollar to recover toward MXN17.50-55. While Mexico's economic growth remains weak in relative and absolute terms, risk of a recession has diminished, and price pressures remain elevated. The central bank meets on February 5. There is little doubt but that it will stand pat, with its key rate at 7.0%.

Spot: MXN17.4605 (MXN17.9040) Median Bloomberg One-month forecast: MXN17.8685 (MXN18.0620) One-month forward: MXN17.5040 (MXN17.9570) One-month implied vol: 9.5% (6.8%)

Chinese Yuan:  Chinese officials have engineered a modest appreciation of the yuan. The reference rate for the dollar has been set repeatedly below CNY7.00 for the first time since 2023. The appreciation comes even as the Chinese economic activity disappoints. PBOC officials have indicated there is scope for lower interest rates and reserve requirements. The central bank also injected a record amount of funds into the banking system through longer-dated facilities in January. January was the sixth consecutive month that the yuan appreciated against the greenback. It is the longest streak since the eight-month rally starting in June 2020. Still, the yuan's appreciation has been modest. Since the end of May 2025, the yuan has risen by about 3.5%. While the Malaysian ringgit and Thai baht appreciated more, contrary to conventional wisdom, the appreciation of the yuan did not "free" other local currencies to appreciate. Most fell, including the Japanese yen, Indian rupee, the South Korean won, and Taiwanese dollar. We suspect the appreciation of the yuan is too small to have much impact on trade, while Washington's policy thrust appeared to provide incentives for the EU and Canada find some trade accommodation with Beijing. 

Spot: CNY6.9570 (CNY7.9880) Median Bloomberg One-month forecast: CNY76.9535 (CNY7.0095) One-month forward: CNY6.9625 (CNY6.9970) One-month implied vol: 4.7% (3.1%)

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