Dollar Strength Intensifies as Fed Rate Cut Bets Fade, Market Eyes January FOMC Meeting

The dollar index strengthened to its highest level in a month, climbing +0.20% on Friday as investors reassessed expectations for upcoming Federal Reserve decisions. The shift reflects a softer employment backdrop coupled with sticky wage pressures—a combination that complicates the case for aggressive rate cuts ahead of the crucial FOMC meeting scheduled for January 27-28.

US Labor Market Sends Mixed Signals, Supporting Dollar Resilience

December’s employment data painted a nuanced picture of the American labor market. Nonfarm payrolls expanded by just +50,000, trailing the forecast of +70,000, while November’s figures were trimmed to +56,000 from an initially reported +64,000. Yet simultaneously, the unemployment rate tightened to 4.4%, surpassing expectations of 4.5%, and wage growth outpaced projections at +3.8% year-over-year versus the anticipated +3.6%.

This conflicting narrative—weaker job creation offset by tighter labor supply and accelerating compensation—bolsters the case for maintaining elevated interest rates, a dynamic that underpinned the dollar’s Friday performance. Atlanta Fed President Raphael Bostic echoed this hawkish tone, emphasizing that “inflation remains excessively high” despite recent cooling in labor demand. The current market assessment assigns merely a 5% probability to a -25 basis point reduction at the January 27-28 FOMC meeting, a marked departure from earlier expectations.

Housing and Consumer Sentiment Present Contrasting Trends

October housing data diverged sharply from expectations. Starts plummeted -4.6% month-over-month to a five-year nadir of 1.246 million units, well below the consensus of 1.330 million. Building permits, meanwhile, edged down just -0.2% to 1.412 million, slightly exceeding forecasts of 1.350 million.

Consumer sentiment, however, rebounded strongly. The University of Michigan’s January index surged +1.1 points to 54.0, exceeding the 53.5 projection. Critically, inflation expectations remain sticky: one-year expectations held steady at 4.2% against forecasts of a decline to 4.1%, while five-to-ten-year expectations climbed to 3.4% from 3.2%, topping the 3.3% estimate. These persistent inflation perceptions complicate the Fed’s messaging and support the dollar.

Dollar’s Structural Headwinds Emerge from Fed Divergence

Despite Friday’s strength, the dollar faces substantial structural weakness as the calendar turns toward 2026. Markets now price the FOMC to deliver approximately -50 basis points of cuts throughout 2026, whilst the Bank of Japan is anticipated to tighten policy by an additional +25 basis points. The European Central Bank, by contrast, is expected to maintain rates steady. This divergence—with the Fed easing while foreign counterparts hold or tighten—creates a longer-term headwind for dollar valuations.

Further complicating the outlook is the Federal Reserve’s ongoing liquidity enhancement program. Beginning in mid-December, the FOMC commenced T-bill purchases at a rate of $40 billion monthly, injecting cash into financial markets in a manner reminiscent of quantitative easing. Such accommodation typically pressures reserve currencies.

Geopolitical uncertainties cloud the picture as well. The Supreme Court deferred its ruling on the constitutionality of President Trump’s tariff regime until the following Wednesday, leaving markets in suspense regarding potential disruptions to the US fiscal position. Should the Court invalidate the tariffs, deteriorating revenue could worsen deficits and weigh on the dollar. Additionally, speculation that the Trump administration may appoint a dovish Federal Reserve chair—with National Economic Council Director Kevin Hassett identified as the leading candidate by Bloomberg—raises concerns about monetary policy accommodation and dollar weakness.

Euro Treads Water Despite Brighter Economic Data

EUR/USD declined to a one-month floor, finishing -0.21% lower as dollar strength dominated sentiment. Eurozone November retail sales advanced +0.2% month-over-month, exceeding the +0.1% forecast, with October revised upward to +0.3%. German industrial production surprised to the upside, expanding +0.8% in November contrary to expectations of a -0.7% contraction.

ECB Governing Council member Dimitar Radev struck a neutral stance, suggesting current rate levels remain “appropriate,” whilst derivative markets price virtually zero probability of a +25 basis point hike at the February 5 policy decision. The euro’s limited decline despite dollar momentum suggests support from economic fundamentals, though currency markets remain dollar-bid.

Yen Plunges to Multi-Year Lows; BOJ Inaction Disappoints

USD/JPY surged +0.66% as the yen hit a one-year nadir against the dollar. The Bank of Japan kept rates anchored despite raising its economic growth projection, disappointing yen bulls who anticipated policy normalization. Bloomberg’s report of unchanged BOJ rates—coupled with a strengthening dollar and elevated US Treasury yields—accelerated yen losses.

Japan’s recent economic data offered only modest support. The November leading index climbed +0.7 to a 1.5-year peak of 110.5, meeting expectations, whilst household spending surged +2.9% year-over-year, marking the strongest six-month increase and confounding forecasts of a -1.0% decline. Yet these gains failed to offset political and geopolitical headwinds.

Prime Minister Takaichi’s reported consideration of dissolving the lower house of parliament introduced uncertainty, whilst escalating China-Japan tensions—marked by Beijing’s announcement of export controls on items with potential military applications in retaliation for Japan’s Taiwan comments—threaten supply chains and near-term growth. Additionally, the Japanese government’s fiscal expansion, epitomized by a record defense budget of 122.3 trillion yen ($780 billion) within a broader 122.3 trillion-yen appropriation, raises concerns about yen sustainability. Markets assign zero probability to a BOJ rate hike at the January 23 meeting.

Precious Metals Rally on Monetary Accommodation and Safe-Haven Demand

February COMEX gold futures settled +40.20 (+0.90%), whilst March COMEX silver closed +4.197 (+5.59%), driven by President Trump’s directive to Fannie Mae and Freddie Mac to acquire $200 billion in mortgage-backed securities. This quasi-quantitative easing framework boosts precious metals as inflation hedges and stores of value.

Safe-haven flows persist amid uncertainty surrounding tariff legality and geopolitical tensions spanning Ukraine, the Middle East, and Venezuela. The expectation that the Trump administration may install a dovish Fed chair—potentially engineering accommodative policy through the 2026 FOMC calendar—simultaneously supports precious metals whilst pressuring the dollar.

Central bank gold accumulation remains a powerful tailwind. China’s People’s Bank reported that December holdings climbed +30,000 ounces to 74.15 million troy ounces, marking the fourteenth consecutive month of increases. Globally, central banks purchased 220 metric tons in the third quarter, up 28% sequentially. Fund demand remains robust, with gold ETF long positions at a 3.25-year high and silver ETF longs at a 3.5-year peak.

Headwinds emerged on Friday, however, as the dollar index’s climb to four-week peaks reduced safe-haven demand, and the S&P 500’s advance to record highs similarly diminished precious metals appeal. Additionally, Citigroup flagged potential outflows of approximately $6.8 billion from gold futures and similar volumes from silver over the coming week due to reweighting of the BCOM and S&P GCSI commodity indexes, the sector’s two largest benchmarks.