Navigating Geopolitical Storms: Asia FX Amid Soft US CPI
The recent US CPI data for December revealed a subtle surprise, with core CPI at 0.2% mom, slightly lower than the expected 0.3% mom. This development carries a crucial message: despite the volatility in individual components, the overall inflationary impact from tariffs remains controlled. However, the data also highlighted lingering effects from the government shutdown, with some sectors still grappling with data unavailability.
Airline fares and household equipment costs rose, while appliances, jewelry, watches, and used cars experienced significant disinflation. This nuanced picture underscores the complex interplay between tariffs and economic indicators.
In the realm of monetary policy, the Federal Reserve's trajectory is a topic of intense interest. We anticipate the Fed to cut rates more aggressively than market expectations, driven by a combination of contained inflation and a softer labor market throughout 2026. The ongoing challenges to the Fed's independence and President Trump's advocacy for lower rates further reinforce this perspective. Our forecast predicts US Fed funds rates falling below 3% by the third quarter of 2026.
Across the Asian FX landscape, a dual force of a weakening Japanese yen and rising oil prices exerted pressure on currencies like the Philippine peso (PHP), Indian rupee (INR), South Korean won (KRW), and Thai baht (THB). However, this pressure was also influenced by local factors.
In India, a significant development was the delay in the inclusion of Indian government bonds in the Bloomberg Global Aggregate Index, with an update expected by mid-2026. This delay has sparked discussions about the potential impact on the Indian rupee. The index provider's commitment to an ongoing review of Indian government bonds is a key consideration.
From an FX perspective, the inclusion of Indian bonds in the Bloomberg Global Agg could have attracted substantial flows, estimated at US$15-20 billion over time, assuming an ultimate weight of 0.75-1%. This development would have been particularly crucial given the drying up of capital inflows and tariff uncertainties, intensifying the pressure on the INR to weaken. The upcoming Union Budget 2026, scheduled for February 1, will be a critical catalyst for the INR, as markets scrutinize the government's commitment to fiscal consolidation and its implications for macro stability. We anticipate the USD/INR to rise towards the 92.00 level, underperforming against key G10 and Asian FX pairs.
