Global foreign exchange markets: BofA favors selective USD strength as higher rates, energy risks and volatility pressure challenge broad FX risk-taking.

Overview

This global FX weekly combines macro, central-bank, quantitative, technical and regional analysis. BofA sees a technically supported dollar and difficult conditions for broad EM FX exposure, but emphasizes selective currency and relative-value positions rather than a uniform directional view.

Core views

The dollar is at the strong end of its long-held 96-102 DXY range. BofA notes that post-FOMC front-end US-rate repricing and solid US data have supported the dollar, but its medium-term fundamental forecasts still imply that the range holds. A sustained upside break would require the rest of the world to weaken more decisively. Elevated energy prices are central: prolonged energy inflation could weigh especially on energy-importing economies heading into winter, and further geopolitical escalation would likely coincide with fresh DXY highs. EUR/USD weakness has also reflected widened OAT-Bund spreads; BofA estimates each additional 10bp of spread widening is associated with roughly 0.4% EUR/USD depreciation. Despite this near-term pressure, it keeps EUR/USD forecasts at 1.15 for end-2026 and 1.20 for end-2027. The report remains cautious on broad EM FX. EM rallies have been accompanied by higher volatility risk premia, raising the cost of protection against depreciation. BofA constructs a composite from the median USD/EM one-month 25-delta risk reversal, the one-month/three-month risk-reversal slope, and the implied-versus-realized variance gap. All three measures indicate a gradual repricing of downside risk, but remain below their one-year averages, so they do not yet indicate capitulation or an attractive contrarian long. The rates backdrop complicates the picture: falling US yields driven by growth fears can coincide with a volatility shock and weaker EM FX, while rising yields erode carry. BofA therefore prefers selective intra-regional relative value and idiosyncratic positions over broad EM beta. For G10, the institution remains bullish on JPY on improving Japanese fundamentals and expected faster Bank of Japan hikes, with USD/JPY forecast at 149 by end-2026. It retains constructive medium-term views on EUR, GBP, AUD, NZD and SEK, while leaning bearish on NOK, CAD and CHF. European asset managers have generally reduced USD hedge ratios, which BofA views as a medium-term EUR-positive structural force, though it does not expect imminent adjustments and remains neutral EUR/USD near term. For Nordic FX, a more hawkish Riksbank outlook versus a Norges Bank viewed as near its rate peak shifts relative-rate dynamics against NOK/SEK; BofA estimates the central-bank meetings left NOK/SEK about 0.4% below the level implied by oil alone. Central-bank divergence remains a major driver. BofA expects the RBA to raise its cash rate by 25bp to 4.60% on September 29, citing persistent inflation, tight labor conditions and AI-investment demand effects. It sees a further November hike as possible if the August CPI leads to a 3Q trimmed-mean forecast of 1.0% quarter-on-quarter, and recommends paying November RBA OIS at 34bp, targeting 50bp with a 28bp stop. In Singapore, it expects MAS to steepen the S$NEER slope by 25bp to 1.5% per annum in October, while recognizing that a pause is more likely than a larger 50bp move. Regional views are differentiated. In Latin America, BofA favors Brazil duration, forecasting the Selic at 13.25% by end-2026 and 11.25% by end-2027; its model places five-year yields roughly 75bp above fair value and sees more than 200bp rally potential under a market-friendly election outcome. Mexico faces low growth and medium-term investment-grade concerns, while Colombia's fiscal outlook is weaker after omitted expenditure equal to 2.9% of GDP revealed a potential 2027 deficit of 9.4% of GDP absent corrective action. Chile is becoming a reflation story, with growth expected to rise from about 1.2% in 2026 to 3.0% in 2027 and BofA expecting rates to reach 5% in 2027. Peru is the regional positive, supported by gold and copper, improved politics and forecast growth acceleration from 3.5% in 2026 to 4.4% in 2027. In EEMEA, a hawkish Fed and higher oil prices imply near-term FX weakness against USD, though BofA expects support from December if the US-Iran conflict is resolved and Fed tightening ends. It recommends long AUD/ZAR at 11.57, with a 12.15 target and 11.22 stop, arguing that higher oil, higher US rates and crowded ZAR positioning should pressure the rand while AUD benefits from carry and commodity exposure. Quant signals also favor selective USD strength: option flow, skew, carry and technical continuation signals are constructive, particularly versus EM, but fundamentals remain neutral and USD/JPY has a bearish event signal. BofA identifies bearish GBP/USD as the most attractive USD expression. Technical analysis seeks a September-November DXY rally to 102.50; a break above 101.80-101.98 would support targets of 102.86 and 104.59, while failure to make new highs or loss of key pattern support would weaken the bullish case.

Analysis framework

BofA combines relative interest-rate differentials, macro growth comparisons, energy and geopolitical transmission, central-bank forecasts, options-market pricing, portfolio-flow estimates, quantitative factor signals and technical chart patterns. It applies these tools to identify selective currency expressions rather than relying on a single broad USD or EM FX call.

Methodology notes

• MacroeconomicsInterest rate parity

  Front-end interest-rate differentials and central-bank repricing

  The report treats changing expected policy-rate gaps as an important driver of exchange rates, while noting that other forces such as energy prices and sovereign spreads can alter the relationship.

• Quantitative, Factor, and Portfolio TheoryStyle factor analysis

  Carry, value, momentum, option flow and technical signals

  BofA uses several quantitative signals to assess which FX factors are dominant and concludes that carry and selected trend signals currently favor selective USD exposure.

• Other

  EM FX volatility-risk-premium composite

  The report averages z-scored option risk reversals, term-structure slopes and implied-versus-realized variance gaps to gauge demand for protection against EM currency depreciation.

• Quantitative, Factor, and Portfolio TheoryMean-Variance Analysis (Markowitz)

  Conventional 60/40 portfolio rebalancing estimate

  BofA uses the monthly and quarterly performance of global equities and bonds in a conventional 60/40 allocation to estimate likely month-end currency rebalancing flows.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• DXY

  BofA retains a long USD technical bias.

  Strengths

  Higher highs and lows, a head-and-shoulders base, bullish RSI and MACD signals, and post-FOMC support.

  Weaknesses

  Fundamental forecasts still imply the long-held range holds medium term.

  Comparison

  Preferred versus low-carry FX and commodity importers including CHF, SEK, GBP and PHP.

  Risks

  Failure to make new highs or invalidation of key bottom patterns could shift the technical outlook bearish.

• AUD/ZAR

  Recommended long cross trade.

  Strengths

  AUD benefits from RBA tightening expectations, carry and commodity exposure; ZAR is highly exposed to higher oil and global risk factors.

  Comparison

  BofA views the cross as potentially less volatile than a long USD/ZAR position because of lower beta to broader USD and metals factors.

  Risks

  Lower oil, a more hawkish SARB or a more dovish RBA.

• GBP/USD

  Preferred selective USD-long expression through bearish GBP/USD.

  Strengths

  Bearish positioning, ADX downtrend signals, bearish post-Fed price action, negative CARS signal and broad-based selling.

  Weaknesses

  Value and carry signals are broadly neutral.

  Comparison

  Identified as more attractive than generalized USD exposure.

• USD/PEN

  BofA maintains a short USD/PEN position.

  Strengths

  Improving terms of trade, bullish gold and copper outlook, and stronger projected Peruvian growth.

  Comparison

  Peru is described as one of the more attractive EM FX opportunities.

  Risks

  Peru’s high exposure to copper and gold prices.

Key data

• EUR/USD forecast1.15 at end-2026; 1.20 at end-2027BofA maintained these levels despite small forecast revisions.
• USD/JPY forecast149 at end-2026Supported by improving Japanese fundamentals and expected faster BoJ hikes.
• DXY technical target102.50Target for September-November; technical upside levels include 102.86 and 104.59 after a breakout.
• RBA policy-rate forecast4.60%BofA expects a 25bp hike on September 29.
• Brazil five-year yield valuation gaproughly 75bp above fair valueBofA model estimate, even without improved fundamentals.
• Colombia potential 2027 fiscal deficit9.4% of GDPEstimated if no corrective measures are adopted.
• Chile growth forecastaround 1.2% in 2026 and 3.0% in 2027Fiscal stimulus and investment reforms support stronger growth but raise inflation risk.
• Peru growth forecast3.5% in 2026 and 4.4% in 2027Commodity prices, external accounts and political reforms underpin the outlook.
• Long AUD/ZAR tradeEntry 11.57; target 12.15; stop 11.22Expected carry is about 0.15% per month.

Impact & implications

The report’s central implication is that an environment of elevated energy prices, hawkish policy expectations and rising volatility favors selective rather than broad FX risk-taking. It sees opportunities in USD exposure against chosen low-carry or vulnerable currencies, relative-value EM trades, and currencies supported by differentiated domestic fundamentals or commodity terms of trade.

Risks

• A durable USD breakout depends on weaker rest-of-world growth, sustained elevated energy prices or further geopolitical escalation.
• A growth-scare decline in US yields accompanied by a volatility shock may still weaken EM FX.
• EM FX risk premia are rising but have not reached levels that support a contrarian long.
• Risks to long AUD/ZAR include lower oil prices, a more hawkish SARB and a more dovish RBA.
• The November RBA OIS position faces the risk of a dovish RBA hike.
• Mexico risks include rate hikes by Banxico and substantial MXN depreciation.

What to watch

• US payrolls, PCE, JOLTS, ISM manufacturing, GDP data and Fed speakers.
• Euro-area CPI, sentiment data, ECB speakers, and France’s budget and ratings risks.
• BoJ Tankan, the September Outlook Report, Tokyo CPI and BoJ minutes.
• RBA policy decision and August CPI, particularly whether trimmed-mean inflation implies another November hike.
• Energy prices, developments in the US-Iran conflict and their impact on global growth and FX volatility.
• Singapore labor-market data, CPI food-price trends and the regulated electricity-tariff announcement.
• Brazilian election probabilities, Colombian fiscal execution, and commodity prices relevant to Peru.