Fed's Hawkish Data Signals Pause on Rate Cut Expectations, Supporting Dollar Strength

The dollar index powered to a one-month peak on Friday, gaining +0.20% as market participants reassess the timeline for potential Fed interest rate adjustments. The shift in sentiment stems from a labor market report that painted a nuanced picture: while December nonfarm payrolls expanded by only +50,000 against forecasts of +70,000, the unemployment rate compressed to 4.4% from 4.5%, and wage growth accelerated to +3.8% year-over-year, surpassing the +3.6% projection. This divergence—softer hiring but tighter labor conditions and faster wage growth—has effectively pushed back market expectations for an early Federal Reserve rate cut.

Simultaneously, consumer sentiment indicators turned unexpectedly resilient. The University of Michigan’s January consumer sentiment index jumped to 54.0, outpacing expectations of 53.5. Inflation perception also shifted, with one-year inflation expectations holding steady at 4.2% and five-to-ten-year expectations rising to +3.4% from +3.2%, both scenarios suggesting persistent price pressures. These developments reinforce the narrative that the Fed may maintain a cautious stance longer than previously anticipated, with markets now pricing in only a 5% probability of a -25 basis point rate cut at the January 27-28 FOMC meeting.

Cross-Currency Dynamics: Dollar Dominance vs. Regional Challenges

The strength in the dollar came at the expense of other major currencies. EUR/USD retreated to a one-month low, finishing down -0.21%, as dollar momentum outweighed positive signals from the Eurozone. November retail sales in the Eurozone expanded +0.2% month-over-month versus expectations of +0.1%, while German industrial production surprisingly increased +0.8% month-over-month after forecasts called for a -0.7% contraction. ECB policymakers maintained their dovish rhetoric, with Governing Council member Dimitar Radev suggesting current interest rates “can be assessed as appropriate,” signaling the central bank shows little appetite for adjustment.

USD/JPY climbed +0.66% as the yen deteriorated to a one-year low against the greenback. The Bank of Japan’s decision to hold rates steady despite raising its economic growth projection sparked the yen weakness, compounded by dollar strength and elevated US Treasury yields. Political uncertainty in Japan—with reports that Prime Minister Takaichi is considering dissolving the lower house—further weighed on sentiment. However, Japan’s November leading index rose +0.7 to a 1.5-year high of 110.5, and household spending unexpectedly surged +2.9% year-over-year, marking the largest gain in six months, offering some support to the currency.

The Rate Cut Paradox: Longer-Term Policy Divergence

A critical headwind for the dollar emerges when examining the forward guidance from central banks globally. While the Fed is expected to cut rates by approximately -50 basis points through 2026, the Bank of Japan is anticipated to raise rates by another +25 basis points, and the European Central Bank signals rates may remain on hold. This divergence typically pressures the dollar, yet other factors are offsetting this dynamic. The Fed’s recent liquidity injections—purchasing $40 billion monthly in Treasury bills since mid-December—have expanded the money supply, typically a bearish force for the currency. Compounding concerns is speculation that President Trump may appoint a dovish Federal Reserve Chair in early 2026, a development widely perceived as negative for dollar prospects, as it could signal a return to accommodative monetary policy.

Precious Metals Rally on Policy Uncertainty and Safe-Haven Flows

Gold and silver surged on Friday despite dollar strength, with February COMEX gold futures closing up +0.90% and March COMEX silver futures jumping +5.59%. The rally reflected multiple supportive factors: President Trump’s directive to Fannie Mae and Freddie Mac to purchase $200 billion in mortgage bonds operates as a quasi-quantitative easing measure, which historically benefits precious metals as alternative stores of value. Geopolitical tensions—spanning tariff uncertainty, conflicts in Ukraine and the Middle East, and instability in Venezuela—continue to drive safe-haven demand for bullion.

Central bank accumulation provided additional tailwinds. China’s People’s Bank of China expanded gold reserves by +30,000 ounces to 74.15 million troy ounces in December, marking the fourteenth consecutive month of reserve increases. Global central banks collectively purchased 220 metric tons of gold in the third quarter, up +28% from the second quarter. Fund flows remained constructive, with long holdings in gold ETFs climbing to a 3.25-year high, and silver ETF long positions reaching a 3.5-year high.

Headwinds and Rebalancing Risks

Despite the Friday rally, precious metals faced offsetting pressures. The dollar’s +0.20% gain created headwinds, as a stronger greenback typically suppresses gold and silver prices for international buyers. A looming rebalancing of major commodity indexes—specifically the Bloomberg Commodity Index (BCOM) and S&P Goldman Sachs Commodity Index (GCSI)—poses downside risk, with Citigroup estimating potential outflows of $6.8 billion from gold futures and similar amounts from silver over the subsequent week. The S&P 500’s advance to record highs also reduced the appeal of safe-haven assets as equity markets attracted investor appetite.

The week ahead will prove pivotal as markets calibrate to a rapidly shifting policy landscape where rate cut expectations have contracted, central bank divergence widens, and geopolitical complexity sustains demand for both traditional safe havens and alternative currency reserves.