Strong Dollar Emerges as Rate Hike Odds Fade into January Meeting

The dollar index (DXY) surged to a 4-week peak on Friday, finishing with a +0.20% gain as market participants reassessed Federal Reserve rate-cut probability. Supporting the greenback’s climb was a nuanced employment report—December nonfarm payrolls increased just +50,000 versus expectations of +70,000, yet the unemployment rate contracted to 4.4% (down from 4.5% forecast). For context, at current wage levels averaging +3.8% year-over-year growth, those 50,000 new positions translate to roughly $56,000 annual gains distributed across the labor force, though individual earners saw average hourly earnings push +3.8% upward. Such mixed labor signals kept rate-cut bets limited, with markets pricing only a 5% probability for a -25 basis point cut at the January 27-28 FOMC decision.

Additional tailwinds emerged Friday as University of Michigan’s January consumer sentiment index climbed +1.1 to 54.0, exceeding the 53.5 consensus. Inflation expectations remained sticky: January 1-year projections held at 4.2% while 5-10 year expectations rose to 3.4% from 3.2%. Atlanta Federal Reserve President Raphael Bostic signaled a hawkish stance, stating inflation remains the priority despite labor market softening. Separately, Supreme Court deferred a ruling on Trump tariff legality until January 22, temporarily removing tariff-related dollar headwinds.

However, underlying dollar weakness persists due to Fed liquidity injections—the central bank commenced $40 billion monthly T-bill purchases in mid-December. Markets expect roughly -50 basis points of Fed cuts across 2026, contrasting sharply with BOJ rate increases and ECB stability. Additional pressure stems from speculation that President Trump may appoint a dovish Fed Chair; Bloomberg indicated National Economic Council Director Kevin Hassett represents the market’s most dovish scenario.

Currency Pairs React to Diverging Central Bank Expectations

EUR/USD slipped to a 1-month nadir, declining -0.21% as dollar strength dominated. Eurozone retail sales (+0.2% m/m) and unexpected German industrial production growth (+0.8% m/m) cushioned euro losses. ECB policymaker Dimitar Radev characterized current rates as “appropriate,” with swaps showing negligible odds for February 5 action.

USD/JPY powered higher by +0.66% as the yen tumbled to a 52-week low. Reports that BOJ would maintain rates unchanged despite upgraded growth guidance accelerated yen selling. Political turmoil amplified pressure after reports suggested Prime Minister Takaichi might dissolve parliament. Supply chain escalation—Chinese export controls on Japan-bound military-capable goods—further weighed on the currency amid China-Japan tensions. Supporting data—November leading indicators at 1.5-year highs and household spending +2.9% y/y—proved insufficient countermeasure.

Precious Metals Rally on Monetary Stimulus Narratives

February COMEX gold (GCG26) finished +40.20 points (+0.90%), while March COMEX silver (SIH26) jumped +4.197 (+5.59%) after Trump directed Fannie Mae and Freddie Mac to acquire $200 billion in mortgage bonds—effectively a quasi-quantitative easing signal. Bullion drew support from safe-haven demand amid tariff uncertainty and geopolitical flashpoints spanning Ukraine, the Middle East, and Venezuela.

Central bank accumulation remained a primary driver: China’s PBOC gold reserves climbed by +30,000 ounces to 74.15 million troy ounces in December, marking the fourteenth consecutive monthly increase. Global central banks acquired 220 MT in Q3, up 28% sequentially. ETF positioning strengthened with long gold holdings touching a 3.25-year peak and silver ETF longs reaching 3.5-year highs.

Headwinds included dollar strength and potential commodity index rebalancing—Citigroup estimates potential $6.8 billion outflows from gold futures and comparable silver liquidation during BCOM and S&P GCSI reweighting. Equity market strength, with the S&P 500 marking fresh records, also reduced safe-haven appetite for metals.