Monthly Foreign Exchange Review
FX markets have been quiet despite stronger-than-expected US data. Q3 GDP rose 4.3% and PCE inflation was 2.9%, showing solid growth but consumer sentiment remains extremely negative, highlighting a disconnect between data and how the economy feels.
Markets largely ignored the GDP release as it reflects older activity. While growth and sticky inflation would normally limit rate cuts, markets still expect one US rate cut in early 2026, with a small chance of a second. Looking ahead, falling inflation, weak sentiment, softening housing and the delayed impact of tariffs support the case for further cuts and a weaker USD. With US rates declining while others remain stable or rise, the dollar may face pressure against other currencies in Q1 2026, potentially amplified by inventory restocking and higher imports.
FX markets have been quiet through December, despite the release of government data for the first time in months. Q3 GDP came in much stronger than expected at 4.3%, while the PCE inflation number was 2.9%. This is a solid report. Surprisingly, sentiment data shows consumers are extremely negative on current economic conditions—this is a huge mismatch between the solid growth numbers and how the economy feels to consumers.
The strong GDP number impact on FX markets—and markets more broadly—has been muted. This data is considered old as GDP covered Jul-Aug-Sep only. Normally, the combination of solid growth and stubborn 2%+ inflation is a clear sign to pause any rate cuts. Markets are expecting just one more rate cut in the first six months of 2026, with a slight lean to a possible second cut.
A big factor to consider for 2026 is that the US administration wants a weaker USD as part of the larger economy-wide restructuring. A weaker USD would help to reduce imports and increase US exports. Consider:
- USA economy has falling inflation
- Extremely negative consumer and business sentiment
- US housing market showing signs of price declines
- Tariffs impact in US and globally will be felt in 2026
All of these can be reasons to cut rates. The US is still on a rate cut cycle while the rest of the world has paused or considering rate hikes. Lower relative rates generally mean a weaker currency, so with US rates going down, and international rates stable or going up, the USD may show weakness against the RoW in Q1. The economic impact of tariffs has been small in the USA so far; however, many companies front loaded their purchases in Q2 2025. Those inventories unwound over the second half of 2025, so companies will need to replenish products starting Q1 2026. This could put additional pressure on the USD in Q1.
EUR crept to near the highs of the last six months late in December. ECB is pausing their rate cut cycle as EU growth is steady and inflation contained. The EUR is showing strength against the USD in the last 30 days, with EUR trading 1.1773 going into the holiday break. Six-month high is 1.1867, and any price action above 1.1750 is attractive short timing. EUR could see prices above 1.1900 later in the quarter if US inflation moderates and US cuts push from 1 to 2. Bloomberg expects average price of 1.1800 in Q1.
The British pound climbed to 1.3506 against the USD but still is underperforming relative to the EUR. The UK is one of the few countries also in rate cut mode, and while inflation remains stubborn at 3.2%, low 1.3% growth means these cuts are necessary to escape the doldrums. Analysts polled by Bloomberg predict a median of 1.3400 for the GBPUSD rate in Q1 2026.
CAD has rebounded against the USD, as tariffs become more stable and predictable. The overall tariff levels are lower than expected, leading to recent strength against the USD. Still, tariffs and their impact will dominate the USDCAD rate in 2026. The tariff fallout for the Canadian economy isn’t fully understood yet, and it does seem there could be unilateral changes from the US if trade balances don’t normalize, so possible volatility for USDCAD. Analysts polled by Bloomberg predict a median of 1.3800 for the USDCAD rate in Q1 2026.
JPY continues to weaken against the USD despite the BoJ raising rates to 0.75%. Japan inflation remains high, yet the new conservative government has recommitted to a record-breaking budget deficit with spending on defense, welfare and stimulus. The BoJ has committed verbally to fighting inflation and another hike to 1% is expected, but fighting this fiscal tidal wave will be difficult. Analysts polled by Bloomberg predict a median of 152 for the USDJPY rate in Q1 2026.
MXN has resumed its steady march stronger against the USD, and the manufacturing environment for Mexico is so strong, expect this to continue into 2026. As long as this holds, the MXN will continue to inch stronger month after month. Still, it’s important to remember we have a trade disagreement with Mexico. If trade doesn’t normalize, we could see unilateral tariff movement from the US, causing spikes to above 20.0000 as seen in 2025. Analysts polled by Bloomberg predict a median of 18.41 for the USDMXN rate in Q1 2026.
CNY is reaching strongest levels in several years to 7.01. The USA has pushed full tariff implementation to later in 2026, but anything might happen with this schedule. Tensions seem to be ebbing which may be due to US companies needing China imports to continue to operate. It’s likely there will be further flareups in the war. Analysts polled by Bloomberg predict a median of 7.05 for the USDCNY rate in Q1 2026.
Associated Bank can transact foreign exchanges in more than 100 currencies. Companies interested in learning more about making payments in foreign currencies or in hedging currency exposures should contact their Associated Bank Relationship Banker or the bank’s Corporate Foreign Exchange Department at 866-524-8836 or email fxcapmarkets@associatedbank.com.
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