Dollar Strength Accelerates While Rate Cut Expectations Recede into 2026

The dollar index surged to its highest level in four weeks Friday, posting a +0.20% gain as diminishing prospects for near-term interest rate cuts continued to buoy the greenback. The shift reflects growing consensus that the Fed will maintain its cautious stance longer than previously anticipated, reshaping trader expectations across currency and commodity markets.

Mixed Jobs Data Turns Hawkish

The catalyst came from Friday’s employment report, which painted a contradictory picture. December nonfarm payrolls increased by just 50,000—well below the forecasted 70,000—while the November figure was revised downward to 56,000 from 64,000. Yet the unemployment rate tightened to 4.4%, surprising to the downside from 4.5% expectations. More significantly, average hourly earnings printed at +3.8% year-over-year, exceeding the anticipated +3.6%.

Atlanta Fed President Raphael Bostic amplified the hawkish narrative Friday, stating: “Inflation is too high, and we have to make sure that we don’t lose sight of the fact that even labor markets have gotten cooler and more people are expressing concerns, that we still have this big concern around inflation.” His comments reinforced the case against near-term monetary easing.

Consumer Sentiment Beats as Inflation Risks Linger

University of Michigan consumer sentiment data added to dollar-supportive headlines. The January index climbed to 54.0 from December’s 53.2, surpassing economist calls for 53.5. However, underlying inflation gauges revealed stickiness: one-year inflation expectations held at 4.2% (versus 4.1% forecast), while five-to-ten-year expectations jumped to 3.4% from 3.2%, signaling longer-term price pressures.

These mixed signals reinforced the reality that rate cut expectations are receding substantially. Markets are currently pricing only a 5% probability of a -25 basis point cut at the January 27-28 FOMC meeting. More broadly, swap contracts suggest the Fed will deliver approximately -50 basis points in cuts throughout 2026—a far more dovish trajectory than warranted by current inflation data, but tempered by Trump administration signals of a more accommodative Fed chair selection.

Euro Under Pressure, Yen Tumbles

EUR/USD slipped to a one-month low Friday, finishing -0.21%. Despite the euro’s weakness, downside was limited after Eurozone November retail sales rose +0.2% month-over-month (beating +0.1% expectations) and German industrial production unexpectedly increased +0.8% month-over-month versus a -0.7% forecast. ECB Governing Council member Dimitar Radev reiterated that current rates are “appropriate,” with swaps showing virtually zero odds of a February 5 rate hike.

The yen faced sharper losses as USD/JPY climbed +0.66% Friday to a 52-week high. Bloomberg reported the Bank of Japan will hold rates steady at this month’s meeting despite raising growth projections, disappointing those positioned for yen strength. Political instability headlines—with reports that Prime Minister Takaichi is considering dissolving parliament—compounded weakness. The yen’s decline accelerated after China announced export controls on military-use items destined for Japan, escalating regional tensions and threatening supply chains.

Japan’s economic calendar offered scattered support. The November leading index rose +0.7 to 110.5 (a 1.5-year high), matching forecasts, while household spending unexpectedly jumped +2.9% year-over-year—the largest gain in six months—against calls for a -1.0% decline. Still, these bright spots couldn’t overcome broader yen headwinds tied to divergent monetary policy trajectories and geopolitical risk.

Precious Metals Rally on QE Echoes and Safe-Haven Demand

February COMEX gold soared +0.90% Friday to close +40.20, while March COMEX silver surged +5.59%, gaining 4.197. The rally was fueled by President Trump’s directive to Fannie Mae and Freddie Mac to purchase $200 billion in mortgage bonds—a quasi-quantitative easing measure intended to stimulate housing demand. This shift toward expanded financial liquidity has historically benefited bullion as a store of value.

Safe-haven flows remained constructive amid uncertainty over Trump administration tariffs and mounting geopolitical risks spanning Ukraine, the Middle East, and Venezuela. The December Fed announcement of a $40 billion monthly T-bill purchase program added to liquidity support for precious metals demand.

However, headwinds emerged Friday. The dollar index’s rally to four-week highs pressured metal prices, as did an S&P 500 surge to record levels (reducing safe-haven rotation). Citigroup flagged a potential $6.8 billion outflow from gold futures contracts and similar silver liquidation due to commodity index rebalancing across the BCOM and S&P GCSI benchmarks over the coming week.

Central bank demand remained a stabilizing force. China’s PBOC increased holdings by +30,000 troy ounces in December to 74.15 million ounces—marking the fourteenth consecutive monthly increase. The World Gold Council reported global central banks purchased 220 metric tons of gold in Q3, up +28% from Q2. Fund interest also remained robust, with gold ETF long positions climbing to a 3.25-year high Thursday, and silver ETF longs reaching a 3.5-year high in late December.