The Fed's dovish shift triggers pressure on the dollar, with the DXY index depreciating over 9% year-to-date—how will the 2026 rate cut expectations reshape the market landscape?

After the Federal Reserve unexpectedly signaled dovishness on December 10, the global currency markets experienced a dramatic shift. The US Dollar Index (DXY) fell to 98.313 yesterday, down more than 9.38% year-to-date, hitting a recent low. Behind this dollar weakness is the market’s aggressive re-pricing of interest rate outlooks—investors are betting on multiple rate cuts in 2026, but internal Fed disagreements are becoming increasingly apparent, adding uncertainty to future movements.

Powell Signals Neutral Stance, Market Bets on Aggressive Rate Cuts

The Federal Reserve cut interest rates by 25 bps to a range of 3.50%-3.75% as expected this Wednesday, but Powell’s remarks at the press conference were intriguing. He hinted that the January meeting might pause rate cuts and emphasized, “We have cut rates by a total of 175 bps and are now in a neutral rate range,” implying that further action depends on economic signals.

However, this cautious tone was interpreted differently by the market. The Fed’s new dot plot maintained the median expectation of only one rate cut in 2025, which contrasts sharply with market pricing of two cuts (about 50 bps), triggering a significant sell-off of the dollar. UBS FX strategist Vassili Serebriakov stated, “The market initially expected a more hawkish Fed, but the relatively dovish signals, combined with the RBA, BoC, and ECB turning hawkish, create a stark contrast, which will continue to pressure the DXY index.”

Adding to the pressure, the Fed announced it will purchase $40 billion of short-term government bonds starting December 12 to inject liquidity, further diminishing the appeal of the dollar as a safe-haven asset.

Dollar Weakness Becomes a Gift for Risk Assets

The decline in the DXY index has sent ripples through global asset prices.

Tech stocks and high-beta growth stocks are among the first beneficiaries. The S&P 500 Tech sector has gained over 20% this year, with dollar depreciation boosting export competitiveness and lowering financing costs. JPMorgan data shows that for every 1% decline in the dollar, tech earnings can increase by 5 basis points, benefiting multinational companies in particular.

Gold emerges as the biggest winner. As a safe-haven asset, gold has surged 47% this year, breaking through $4,200 per ounce to hit a record high. Data from the World Gold Council shows global central banks have net purchased over 1,000 tons (led by China and India), ETF inflows have surged, and the weakening dollar has amplified demand for inflation hedging.

Emerging markets see a capital influx. The MSCI Emerging Markets Index has risen 23% this year, with stocks in South Korea, South Africa, and others leading the gains due to strong corporate earnings and the dual tailwind of a weaker dollar. Goldman Sachs research indicates that dollar weakness is stimulating capital flows into emerging market bonds and equities, with currencies like the Brazilian real appreciating accordingly.

Double-Edged Sword: Hidden Risks Amid Prosperity

However, dollar weakness is not purely positive. Commodity prices are rising—crude oil up about 10%—intensifying inflation concerns and constraining future central bank policies. If US stocks overheat, high-beta assets could see increased volatility, posing risks to investment portfolios.

A Reuters poll shows that 73% of 45 analysts expect the dollar to weaken further by year-end, but this consensus is not infallible. If December’s CPI data (expected to be released on December 18) comes in strongly, the DXY could rebound to the 100 level, reversing recent bearish expectations.

Employment Data Will Be a Key Turning Point for the DXY

In the short term, the probability of further dollar weakening remains high, but the long-term trend is uncertain. J.P. Morgan economist Mohit Kumar said, “The chance of a rate cut at the January meeting is 50/50, and employment data will be a critical turning point. The market is currently overreacting to labor market signals.”

If December’s employment report exceeds expectations (similar to the surprise of adding 119,000 non-farm jobs in September), Fed dissent (three members opposed rate cuts this time) could turn hawkish, pushing the DXY index back to 100. Additionally, the widening US fiscal deficit and government shutdown fears could temporarily support the dollar’s safe-haven demand.

Investment Allocation Recommendations

The market is currently at a critical juncture of re-evaluating monetary policy. Analysts suggest that in an environment of increased volatility, investors should diversify into non-US currencies and gold assets, carefully assess leverage levels, and remain flexible to respond to potential fluctuations in the DXY index.