Fed Rate Cut Bets Collapse: Dollar Surges While Markets Recalibrate

The Dollar Index staged a powerful comeback on Friday, climbing to fresh 1-month highs and finishing the session +0.20% as rate cut expectations continue evaporating. The catalyst? A disjointed US labor report that simultaneously signaled wage pressures and cooling employment—the kind of mixed signals that keep the Fed from pulling the trigger on rate cuts.

The Payroll Puzzle That’s Keeping the Fed Hawkish

December nonfarm payrolls came in at +50,000, disappointing forecasts of +70,000 and marking a significant miss that triggered downward revisions to November figures (now +56,000 from +64,000). Yet the unemployment rate actually tightened to 4.4%, defying expectations of 4.5%, while hourly wage growth accelerated to +3.8% year-over-year versus anticipated +3.6%. This contradiction—weak job creation coupled with stubborn wage inflation—is exactly what keeps policymakers vigilant about premature rate cuts.

The University of Michigan’s January consumer sentiment index further complicated the rate-cut narrative, jumping to 54.0 (vs. 53.5 expected). More concerning for rate-cut advocates: inflation expectations made a sharp reversal upward. One-year inflation expectations held flat at 4.2% while the longer-dated 5-10 year view climbed to 3.4% from 3.2%, both figures exceeding predictions for moderation.

Atlanta Fed President Raphael Bostic reinforced this cautious stance Friday, emphasizing that “inflation is too high” despite evidence of labor market softening. The market currently prices in just a 5% probability of a -25 basis point Fed rate cut at the January 27-28 meeting, a dramatic collapse from earlier optimism.

The Structural Headwinds Hitting the Dollar

Despite Friday’s strength, fundamental forces continue working against the Dollar Index. The Fed remains trapped in a liquidity paradox—even as it signals higher-for-longer rates, it’s simultaneously begun injecting $40 billion monthly in T-bill purchases, undercutting its own hawkish message. Longer-term, markets are handicapping approximately -50 basis points of Fed rate cuts through 2026, a dovish trajectory at odds with current rhetoric.

The appointment uncertainty surrounding the next Fed Chair amplifies this conflict. President Trump’s anticipated announcement of his selection in early 2026—with Kevin Hassett reportedly the frontrunner and viewed as markedly dovish—threatens to erode dollar support if markets price in a more accommodative Fed era.

Supreme Court rulings also loom large. Friday’s decision to defer judgment on Trump’s tariff legality until Wednesday next week injects uncertainty; any ruling striking down tariffs could pressure the dollar by widening the US budget deficit and reducing tariff revenues.

Euro Holds Firm Despite Dollar Strength

EUR/USD slipped to 1-month lows, closing down -0.21%, as dollar muscle flexed. However, eurozone resilience limited the damage. November retail sales expanded +0.2% month-over-month (beating +0.1% estimates), while German November industrial production unexpectedly surged +0.8% after forecasters anticipated a -0.7% contraction. ECB Governing Council member Dimitar Radev characterized current rate levels as “appropriate,” with swaps pricing a negligible 1% odds of any February 5 rate adjustment.

Yen Plunges to Yearly Lows as BOJ Stays Pat

USD/JPY ascended +0.66% Friday, with the yen plummeting to 1-year lows against the dollar after Bloomberg reported the Bank of Japan will maintain rates steady despite upgrading growth projections at this month’s policy decision. Market pricing shows zero probability of a BOJ hike at the January 23 meeting.

Political turbulence intensified yen weakness after reports surfaced that Prime Minister Takaichi is exploring dissolution of the lower house, introducing governance uncertainty. More ominously, China’s announced export restrictions on military-applicable items to Japan—retaliation for Taiwan contingency rhetoric—threaten supply chain disruption and economic headwinds.

Counter-supportive data arrived in the form of November’s leading index climbing to 1.5-year highs and household spending jumping +2.9% year-over-year, marking the strongest performance in six months. Yet escalating China-Japan tensions and Japan’s record defense spending plans (part of a 122.3 trillion-yen budget) continue fraying yen demand amid fiscal anxiety.

Precious Metals Rally on QE-Like Policy and Safe-Haven Demand

February COMEX gold futures surged +40.20 points (+0.90%) while March silver gained +4.197 (+5.59%) as President Trump’s directive to Fannie Mae and Freddie Mac to acquire $200 billion in mortgage bonds triggered fresh demand for hard assets. The policy maneuver—functioning as quasi-quantitative easing—lifted precious metals as investors seek inflation hedges amid policy volatility.

Central bank buying dynamics remain supportive. China’s PBOC expanded bullion reserves by +30,000 ounces to 74.15 million troy ounces in December, marking the fourteenth consecutive monthly accumulation. Global central banks collectively purchased 220 metric tons in Q3, up +28% from Q2, signaling structural bid beneath prices.

Fund positioning also climbed. Gold ETF long holdings reached 3.25-year peaks Thursday while silver ETF longs hit 3.5-year highs on December 23. However, headwinds emerged from strong dollar dynamics Friday and cautionary signals from Citigroup, which flagged potential $6.8 billion outflows from gold futures (with comparable silver drainage) stemming from commodity index reweighting across BCOM and S&P GCSI benchmarks. The S&P 500’s surge to fresh records further muted precious metals’ safe-haven appeal.