The U.S. dollar held on to recent gains on Monday as investors assessed what monetary policy might look like under a Federal Reserve led by Kevin Warsh, particularly his preference for maintaining a smaller balance sheet.
The Japanese yen also returned to focus after Prime Minister Sanae Takaichi highlighted the advantages of a weaker currency during a campaign speech over the weekend. Her remarks appeared to contrast with the stance of Japan’s finance ministry, which has been working to curb the yen’s decline.
Markets reacted sharply on Friday after U.S. President Donald Trump nominated Warsh as the next Fed chair. The announcement triggered selling across risk assets, pushed precious metals sharply lower, and helped the dollar recover losses from earlier in the week.
While investors expect Warsh to lean toward interest rate cuts, they also anticipate tighter control of the Fed’s balance sheet. Such an approach typically supports the dollar by limiting liquidity in financial markets.
The greenback remained firm during early Asian trading on Monday. The euro stayed well below the $1.20 level, last trading at $1.1848. Sterling slipped 0.05% to $1.3680, while the dollar index steadied at 97.22 after surging 1% on Friday.
Richard Clarida, global economic adviser at PIMCO and former Federal Reserve vice chair, said Warsh would inherit a Federal Open Market Committee divided over the pace and scale of future easing. However, Clarida said he expects Warsh to deliver two interest rate cuts this year, with a possible third.
Clarida added that beyond the initial cuts, Warsh could become more cautious, depending on the inflation outlook. He also noted that Warsh is likely to rely less on forward guidance when communicating the future path of interest rates.
Elsewhere in currency markets, the Australian dollar fell 0.54% to $0.69255, while the New Zealand dollar slipped 0.3% to $0.6001.
Yen weakens ahead of Japan election
The Japanese yen weakened further on Monday, falling 0.4% to 155.39 per dollar. The move was driven by broad dollar strength and Takaichi’s comments, which were seen as implicitly supporting a weaker currency.
A survey conducted by the Asahi Shimbun showed Takaichi’s party is on track for a landslide victory in the upcoming lower house election.
Tony Sycamore, a market analyst at IG, said the February 8 snap election is likely to be the next major domestic catalyst for the yen.
Sycamore noted that a clear majority for the ruling LDP could push the USD/JPY pair toward 160, while a coalition outcome could keep the pair closer to the 155 level, depending on the partners involved.
In the lead-up to the vote, investors have sold both the yen and Japanese government bonds. Markets are pricing in expectations of more expansionary fiscal policy if Takaichi secures a strong mandate, along with tax cuts that could further strain Japan’s public finances.
Despite recent weakness, the yen has found some support in recent sessions. Traders remain alert to the possibility of coordinated intervention by the U.S. and Japan, following discussions over exchange-rate checks late last month that briefly sent the currency higher.
