Greenback Strengthens as Rate Cut Expectations Diminish

Strong Labor Report and Inflation Signals Support Currency Rally

The US dollar climbed to its strongest level in four weeks on Friday, gaining 0.20% as mixed employment figures combined with persistent inflation pressures to reshape market expectations around Federal Reserve policy. While December nonfarm payrolls disappointed at 50,000 versus the anticipated 70,000, and November’s reading was downwardly revised to 56,000 from 64,000, the unemployment rate tightened to 4.4%—beating forecasts of 4.5%. This divergence created a hawkish backdrop, particularly as average hourly earnings accelerated to 3.8% year-over-year, surpassing the 3.6% estimate.

The confluence of these indicators shifted market pricing dramatically. Traders now assign merely a 5% probability to a 25 basis point rate reduction at the January 27-28 FOMC meeting, a stark reversal from earlier expectations of multiple cuts in 2026. Instead, the Fed’s commitment to tackling inflation before easing became the dominant narrative.

Consumer sentiment data offered additional support for dollar positioning. The University of Michigan’s sentiment index for January rose 1.1 points to 54.0, exceeding the 53.5 consensus. Yet inflation expectations remained sticky: one-year inflation outlooks held steady at 4.2% (above the 4.1% forecast), while five-to-ten-year expectations climbed to 3.4% from December’s 3.2%, overshooting the 3.3% call. Atlanta Fed President Raphael Bostic reinforced this hawkish tone on Friday, emphasizing that inflationary risks persist despite softening in labor demand.

Policy Divergence Creates Currency Advantage

Market expectations now suggest the Federal Reserve will deliver only approximately 50 basis points of easing throughout 2026, a substantial markdown from previous projections. This contrasts sharply with the Bank of Japan’s anticipated 25 basis point tightening and the European Central Bank’s expected pause. The disparity in monetary trajectories has become the dominant driver of currency flows.

Complicating this picture is the Fed’s ongoing quantitative easing program—$40 billion in Treasury bill purchases commenced in mid-December. Additionally, speculation swirled around a potential dovish Federal Reserve chair appointment, with market participants noting Bloomberg reporting that Kevin Hassett emerged as a leading candidate, with an announcement expected in early 2026. These dynamics have created cross-currents in the greenback’s near-term direction.

A Supreme Court decision to delay its ruling on tariff legality until the following Wednesday added another layer of uncertainty. Should tariffs face legal challenges, currency analysts warned that reduced tariff revenue could widen the US budget deficit, creating depreciation pressures on the dollar.

Euro Pressure Mounts Despite Economic Resilience

The common currency declined 0.21% against the dollar on Friday, slipping to a one-month trough as greenback strength overwhelmed supportive European economic data. Eurozone retail sales for November expanded 0.2% month-over-month, beating the 0.1% forecast, with October’s reading revised higher to 0.3% from flat. German industrial output delivered an even more impressive surprise, climbing 0.8% rather than the consensus call for a 0.7% decline.

ECB Governing Council member Dimitar Radev commented that prevailing interest rates remain calibrated to current economic conditions and inflation dynamics. Market pricing suggests negligible—just 1%—probability of a 25 basis point rate hike at the February 5 policy meeting. The lack of near-term ECB action, combined with the Fed’s hawkish lean, has left the euro vulnerable despite fundamentally supportive data.

Yen Tumbles to Annual Lows as BoJ Holds Steady

The USD/JPY pair appreciated 0.66% on Friday, pushing the yen to its weakest level against the dollar in twelve months. The Bank of Japan is widely anticipated to maintain rates at its January 23 meeting—market pricing shows zero probability of a rate hike—even as the institution raises its economic growth forecast. This dovish hold contrasts with underlying economic strength: Japan’s November leading composite index reached a 1.5-year high at 110.5, precisely meeting expectations, while household spending surged 2.9% year-over-year, the strongest performance in six months and vastly exceeding the 1% decline forecast.

Political turbulence in Japan added to yen selling pressure. Reports of Prime Minister Takaichi considering parliament dissolution created uncertainty among international investors. Additionally, mounting geopolitical tensions between China and Japan—including new Beijing-imposed export controls on items with potential military applications—weighed on the currency. Japan’s government announcement that defense spending would reach a record 122.3 trillion yen ($780 billion) in the next fiscal year raised fresh concerns about fiscal sustainability.

Precious Metals Surge on Accommodation Expectations and Safe-Haven Flows

Gold and silver posted strong Friday performances, with February COMEX gold settling up $40.20 (+0.90%) and March COMEX silver closing +$4.197 (+5.59%). The rally accelerated after President Trump directed Fannie Mae and Freddie Mac to acquire $200 billion in mortgage-backed securities—a monetary accommodation measure designed to reduce borrowing costs and stimulate housing demand. Investors interpreted this quasi-quantitative easing as a catalyst for precious metals demand.

Broader geopolitical headwinds—encompassing US tariff policies, Ukraine and Middle East tensions, and Venezuelan instability—provided additional safe-haven support for both metals. The market’s conviction that the Fed would maintain an accommodative stance throughout 2026, combined with expanding financial system liquidity, underpinned demand for inflation hedges.

However, offsetting pressures emerged from multiple directions. The dollar’s surge to a four-week high created headwind for dollar-denominated commodities. Analyst houses like Citigroup flagged potential significant outflows stemming from commodity index rebalancing, with estimates suggesting approximately $6.8 billion could exit gold futures and a similar volume could depart silver futures as major indexes reweight holdings. The S&P 500’s achievement of a fresh record high on Friday also diminished safe-haven appeal for the metals.

Central bank purchasing activity remained a stabilizing force. China’s central bank expanded gold reserves by 30,000 ounces in December, marking the fourteenth consecutive monthly accumulation. Global central banks collectively purchased 220 metric tons of gold during the third quarter—a 28% surge versus the preceding quarter—according to the World Gold Council. Investor ETF positioning reflected robust appetite: gold exchange-traded fund holdings reached a 3.25-year high, while silver holdings hit a 3.5-year peak in late December.

Housing Data Signals Structural Weakness

October housing starts slumped 4.6% month-over-month to 1.246 million units, marking the lowest reading in five and a half years and undercutting the 1.33 million forecast. Building permits edged down 0.2% to 1.412 million, though this reading exceeded expectations of 1.35 million. The deterioration in housing starts raised questions about residential construction momentum heading into 2026, suggesting potential headwinds for economic growth acceleration.