Global Rates & FX Views: August summer guide

U.S. Rates and Federal Reserve Outlook

• Soft macro data (retail sales, CPI, PPI, and labor reports) has significantly reduced market urgency for further Federal Reserve rate hikes.
• Current market pricing reflects approximately 7.5 bps for September and a total of 30 bps for the remainder of the rate cycle.
• Bank of America Global Research expects the Fed to remain patient in September, barring a major shift in incoming data.
• The likelihood of a September rate hike has dropped from 70% two weeks ago to approximately 30%.
• Historical precedent since 1990 indicates the Fed has never initiated a hiking cycle prior to a general U.S. election.
• Consequently, B of A expects the next rate move is unlikely to occur until December if September is skipped.
• The firm has closed its "two-year pay-to-two-year" recommendation and its "2s-10s flattener" trade due to the shift in the policy environment.
• The primary risk to this neutral/bearish short-end view is a potential reacceleration in economic data or renewed emphasis on tightening.

Bank of Japan (BOJ) and Yen Strategy

• B of A has revised its BOJ expectations, now projecting rate hikes in September and December 2026, plus March and July 2027.
• These projections aim to bring the BOJ policy rate to 2% by the middle of 2027, which clients view as necessary to stabilize the dollar-yen rate.
• The FX team maintains a bullish view on the Japanese yen, particularly against low-yielding peers, despite recent volatility.
• The base case scenario involves coordinated efforts by the U.S. and Japan to push USD/JPY below 155.00 to alter market sentiment sustainably.
• A risk exists that policy intent may shift to maintaining USD/JPY within a 155.00–160.00 range while focusing on BOJ rate hikes.
• The yen is supported by an improving balance of payments, with capital inflows finally matching structural outflows for the first time in years.

Canadian Rates and Euro/Dollar FX

• Despite stronger-than-expected Canadian labor data, B of A anticipates the Bank of Canada (BOC) will remain on hold to address a negative output gap and technical recession risks.
• The firm retains a bias toward long-duration Canadian rates, specifically in the front-end and "belly" (mid-duration) of the curve.
• European gas prices remain elevated due to Middle East uncertainty, which acts as a ceiling for Euro appreciation against the Dollar.
• The FX team closed its short EUR/USD position in June and currently holds a neutral year-end forecast of 1.15.
• Market positioning metrics show that Euro shorts have been significantly reduced, creating a "light" positioning landscape heading into the summer.
• Upcoming events like Jackson Hole and further U.S. data releases make a decisive flip to a short-dollar view currently difficult.

Key Risk Events and Forward-Looking Catalysts

• Jackson Hole (August 28): Market participants will focus on Chair Powell's communication for signals regarding inflation credibility and the Fed's reaction function.
• Fed Minutes (August 18): The release is expected to validate or challenge the new framework of a patient Fed stance.
• Japan Fiscal Budget (September): Watch for government department submissions regarding fiscal prudence for FY2027, which impacts currency stability.
• German State Election (Early September): The Saxony-Anhalt election is a key risk event due to the high polling of the right-wing AfD party, potentially increasing the European fiscal risk premium.
• Xi-Trump Summit (September): Preliminary discussions are monitored via the Chinese Renminbi; positive sentiment typically leads to token RMB appreciation, while tension leads to stabilization.
• Japanese Household/Institutional Flows: Monitor for potential government incentives (e.g., public pension funds) to rotate foreign assets back to domestic holdings.