Did the Fed Cut Rates? Market Signals Point to a Hawkish Hold as Dollar Strengthens

The dollar index (DXY) surged to a one-month peak on Friday, gaining +0.20%, as fresh economic data dimmed expectations for Fed rate cuts in the near term. The hawkish undertone in the labor market and inflation figures kept investors betting heavily against an imminent rate reduction at the Federal Reserve’s January 27-28 meeting, where swaps are pricing in only a 5% probability of a -25 basis point cut.

Economic Data Tilts Hawkish Despite Mixed Signals

Friday’s employment report sent mixed messages, but the hawkish components dominated market sentiment. U.S. December nonfarm payrolls rose just +50,000, undershooting the +70,000 forecast, while November readings were revised lower to +56,000 from +64,000. However, the jobless rate fell -0.1 percentage points to 4.4%, beating expectations of 4.5%, and average hourly earnings surged +3.8% year-over-year versus the anticipated +3.6% y/y—a combination suggesting labor market resilience that could extend the Fed’s cautious stance on rate cuts.

Consumer confidence also bolstered the dollar’s position after the University of Michigan’s January sentiment index climbed +1.1 to 54.0, exceeding the 53.5 forecast. Inflation expectations proved stickier than anticipated, with the one-year inflation gauge holding steady at 4.2% versus the 4.1% projection, and the five-to-ten-year outlook rising to +3.4% from 3.2%, both measures suggesting inflation remains a Fed priority.

Housing data painted a bleaker picture, with October starts plummeting -4.6% m/m to a 5.5-year low of 1.246 million units, though October permits slightly exceeded expectations at 1.412 million, offering modest relief.

Fed Policy Path: Rate Cuts Deferred, Not Eliminated

The market’s assessment reveals a 0% probability of a rate hike at the January 23 BOJ meeting, but the more consequential question—did the Fed commit to cutting rates?—remains unresolved. Current pricing suggests the Federal Reserve may reduce rates by approximately -50 basis points throughout 2026, a gradual descent rather than an aggressive pivot. Atlanta Fed President Raphael Bostic reinforced this cautious outlook, stating, “Inflation is too high, and we have to make sure that we don’t lose sight of the fact that even labor markets have gotten cooler and more people are expressing concerns, that we still have this big concern around inflation.”

Adding headwinds to dollar weakness, the Fed has injected $40 billion monthly in T-bill purchases since mid-December, expanding system liquidity. However, market concerns about President Trump’s anticipated dovish Fed Chair appointment—with Bloomberg reporting National Economic Council Director Kevin Hassett as the leading candidate—threaten longer-term dollar stability, especially as Trump plans to reveal his selection in early 2026.

EUR/USD Under Pressure Despite Eurozone Strength

EUR/USD descended to a one-month low, closing -0.21% on Friday as dollar strength overwhelmed positive eurozone developments. November retail sales in the eurozone advanced +0.2% m/m against +0.1% expectations, with October revised upward to +0.3% m/m. German industrial output unexpectedly jumped +0.8% m/m versus forecasts of -0.7% m/m, yet these gains couldn’t offset dollar momentum.

ECB Governing Council member Dimitar Radev signaled policy continuity, noting “the current level of interest rates can be assessed as appropriate,” with swaps pricing in just a 1% probability of a +25 basis point hike at February’s meeting. The euro faces structural headwinds from rate differentials and softer growth prospects compared to the U.S. labor market’s resilience.

Yen Tumbles on BOJ Rate Hold; Political Uncertainty Adds Pressure

USD/JPY climbed +0.66% Friday as the yen tumbled to a one-year low, with Bloomberg reporting the Bank of Japan will maintain rates unchanged this month despite upgrading its economic growth outlook. Political instability surfaced after reports that Prime Minister Takaichi is considering dissolving the lower house of the National Diet, rattling confidence in the yen as a safe haven.

Japan’s November leading economic index reached a 1.5-year high of 110.5, and household spending surged +2.9% y/y—the strongest six-month gain and well ahead of the -1.0% forecast. Yet these domestic bright spots couldn’t shield the currency from escalating China-Japan tensions following Beijing’s export controls on military-applicable goods, and fiscal pressures as Tokyo boosts defense spending to record levels within its approved 122.3 trillion-yen ($780 billion) budget.

Precious Metals Rally on Liquidity and Tariff Uncertainty

February COMEX gold closed up +40.20 (+0.90%), while March COMEX silver surged +4.197 (+5.59%), as President Trump directed Fannie Mae and Freddie Mac to purchase $200 billion in mortgage bonds—a quasi-quantitative easing maneuver supporting precious metals as stores of value. Geopolitical uncertainty surrounding U.S. tariffs, Ukraine, the Middle East, and Venezuela, combined with expectations of an easier Fed stance in 2026, underpinned safe-haven demand.

Central bank appetite remains robust, with China’s PBOC reserves climbing by +30,000 ounces to 74.15 million troy ounces in December—the fourteenth consecutive month of increases. Global central banks purchased 220 metric tons in Q3, up +28% from Q2. Fund positions strengthened further, with gold ETF long holdings reaching a 3.25-year high Thursday and silver ETF holdings hitting a 3.5-year peak on December 23.

Yet headwinds emerged as the dollar’s four-week climb dampened metals, and the S&P 500 hit fresh record highs, reducing safe-haven appeal. Citigroup warns of potential $6.8 billion outflows from gold futures and similar silver outflows over the coming week due to BCOM and S&P GCSI index reweighting.

The Outlook: Data-Dependent Hold

With the question of whether the Fed will cut rates now tempered by incoming data, the market has shifted from anticipating aggressive easing to pricing a measured approach. The dollar’s current strength reflects this reality, though longer-term vulnerabilities persist from policy uncertainty and the incoming administration’s monetary policy preferences.