US dollar edged up: The DXY index rose to 98.50 on Wednesday following stronger than expected labour market data and hawkish Fed minutes. However, it later closed at 98.32. Initial jobless claims data came in lower than expected at 199K (vs. consensus estimate: 219K) and cast a shadow over the pace of future rate cuts. Further, Fed minutes reaffirmed that the FOMC was divided over the December rate cut and is likely to maintain a status quo in January. We do not expect the Fed to deliver another rate cut in January but overall see 1-2 rate cuts by the middle of 2026 by the Fed. We continue to hold on to our view that the dollar index could see a rebound in 2026 once the rate cut cycle is behind us or nears its end.
Verbal support from JPY: The USD/JPY pair stood at 156.65 on Wednesday, close to levels that have recently prompted comments by Japanese officials to provide support to the currency and prevent further sharp weakness. We expect the USD/JPY pair to trade in the range of 154-158 over the coming quarter and any meaningful gains in the JPY could remain elusive for now as the pace of rate hikes by the BoJ remain gradual and spread out during 2026.
Yuan moved below 7.0: The USD/CNY pair moved below the 7.0 mark earlier this week and stood at 6.99 at the time of writing. The pair gained on the back of strong incoming data and seasonal Yuan demand. Further, stimulus measures announced by the Chinese Government also led to some improvement in sentiments. China Manufacturing PMI returned to the expansionary zone (above 50 reading) in Dec-25 after contracting for eight consecutive months. On the policy front, Chinese authorities announced fiscal stimulus worth USD 51 billion to support consumption and investment in 2026. Moreover, VAT on certain home sales (where ownership is 2+ years) was scrapped to address slump in the property sector. We see the pair trading in the range of 6.9-7.0 by Mar-end.
Domestic bond market: Domestic 10Y benchmark yield closed largely firm at 6.60% yesterday vs. the previous close of 6.59%, ahead of the g-sec auction scheduled later today and announcement around the states’ borrowing calendar for Q4. We estimate Q4 gross borrowings by states in the range of INR 4.5-5.0 lakh Cr. We expect the 10Y benchmark yield to trade in the range of 6.55%-6.60% in the very near term. However, the 10Y could move towards 6.65-6.70% levels, in case states’ Q4 gross borrowing target tops INR 5.0 lakh Cr.
Liquidity: System liquidity moved back into surplus on Wednesday, with the surplus tracking at INR ~17,335 Crores. The improvement in liquidity conditions was on the back of OMO purchases (worth INR 50,000 Cr), & VRR operations by the RBI along with the month-end Government spending. The RBI will conduct a 5-day VRR auction worth INR 1 lakh Cr today. Looking ahead, liquidity conditions are likely to improve/remain manageable with the RBI injecting durable liquidity worth ~INR 2.5 lakh Cr in Jan-26 through OMO purchases and the FX swap.