As FOMC Meeting Looms, Fed Rate Cut Bets Diminish While Dollar Strengthens

Dollar Index Reaches One-Month Peak Amid Shifting Rate Expectations

The dollar index surged to its highest level in four weeks on Friday, gaining +0.20% as market participants reassess expectations for future monetary policy tightening. The currency’s strength reflects a complex backdrop of economic data that simultaneously signals labor market resilience and persistent inflation concerns—factors that may keep policymakers on hold heading into the FOMC meeting on January 27-28.

Economic Data Paints Mixed but Hawkish Picture

December’s employment report presented a paradox. Nonfarm payrolls expanded by only 50,000, trailing forecasts of 70,000, while November’s figure was revised downward to 56,000 from 64,000. Yet simultaneously, the unemployment rate tightened to 4.4%, beating expectations of 4.5%. More notably, average hourly earnings rose 3.8% year-over-year, outpacing the anticipated 3.6%. This combination of softer job growth alongside stronger wage pressures created an environment supportive of the dollar, as it suggests the Federal Reserve may maintain its cautious stance rather than pivot toward aggressive rate cuts.

Housing data revealed additional weakness, with October construction starts declining 4.6% month-over-month to a 5.5-year low of 1.246 million units. Building permits, however, stabilized near expectations at 1.412 million. Consumer sentiment improved unexpectedly, with the University of Michigan’s January index climbing to 54.0 from 53.5, signaling Americans’ growing optimism.

Rate Cut Odds Nearly Evaporate for FOMC Meeting

The financial markets are now pricing in just a 5% probability of a 25 basis point rate cut at the forthcoming FOMC meeting, down sharply from earlier expectations. This dramatic shift reflects renewed hawkish sentiment as participants grapple with the inflation reality: one-year inflation expectations held steady at 4.2%, while five-to-ten year expectations rose to 3.4% from 3.2%.

Atlanta Federal Reserve President Raphael Bostic reinforced this hawkish tone, stating that inflation remains “too high” despite acknowledgment that labor markets have “gotten cooler.” His comments provided emotional support for the dollar’s rally.

However, the dollar faces structural headwinds. The FOMC is expected to deliver approximately 50 basis points of cuts throughout 2026, while the Federal Reserve has already commenced purchasing $40 billion monthly in Treasury bills to inject liquidity into financial markets. Adding pressure, speculation swirls that President Trump will nominate a dovish Fed Chair in early 2026—potentially Kevin Hassett—which markets perceive as coin-negative for the currency.

Euro Slides but Finds Support in Better Data

EUR/USD retreated to a one-month low, finishing down 0.21%. While dollar strength weighed on the euro, eurozone economic news provided some cushion. November retail sales advanced 0.2% month-over-month versus expectations of 0.1%, and German industrial production surprised with an 0.8% increase rather than the forecasted 0.7% decline. ECB Governing Council member Dimitar Radev suggested policymakers view current rates as “appropriate,” with markets assigning only a 1% probability to a rate hike at the February 5 gathering.

Yen Tumbles to One-Year Lows Despite Mixed Signals

USD/JPY climbed 0.66% as the yen surrendered ground against the greenback, sliding to 12-month lows. Bloomberg reported that the Bank of Japan will hold rates steady at this month’s decision despite revising economic growth projections upward—a dovish signal that pressured the currency. Political uncertainty also weighed, with reports suggesting Prime Minister Takaichi may dissolve the lower house of parliament.

Offsetting these headwinds, Japan’s leading economic indicators ticked higher, with the November CI index reaching a 1.5-year high, and household spending surged 2.9% year-over-year—the strongest increase in half a year. Geopolitical tensions, including Chinese export controls on materials with potential military applications and concerns about Beijing’s intentions toward Taiwan, further complicated the yen’s outlook. Japan’s government also approved a record 122.3 trillion-yen defense budget for the coming fiscal year.

Precious Metals Rally on Easier Policy Expectations and QE-Like Measures

February COMEX gold closed up 0.90% to settle sharply higher, while March COMEX silver surged 5.59%. The rally gained momentum after President Trump directed Fannie Mae and Freddie Mac to purchase $200 billion in mortgage bonds—a quasi-quantitative easing operation that traditionally props up safe-haven assets.

Bullish support for precious metals derives from multiple sources: expectations that the Fed will pursue easier policy in 2026 given dovish Fed Chair speculation, increased central bank demand following China’s PBOC reserves jumping by 30,000 ounces to 74.15 million troy ounces in December (marking fourteen consecutive months of accumulation), and strong fund demand with gold ETF long positions climbing to 3.25-year highs.

Safety-seeking flows remain underpinned by geopolitical risks spanning Ukraine, the Middle East, and Venezuela, alongside uncertainty surrounding President Trump’s tariff agenda. Conversely, headwinds emerged as the dollar strengthened and the S&P 500 reached record highs, reducing safe-haven demand. Additionally, Citigroup estimates that commodity index reweighting could trigger $6.8 billion in gold futures outflows and similar sums in silver over the coming week.

Global central banks’ robust appetite remains a stabilizing force, with the World Gold Council reporting 220 metric tons of purchases in the third quarter—a 28% increase from the prior quarter.