Fed Rate Cut Bets Weigh on Dollar as Yen Weakness Adds Complexity

Greenback Performance and Underlying Pressures

The dollar index advanced 0.15% on Friday, propelled by euro and yen declines that both hit 1.5-week lows versus the greenback. Rising Treasury note yields supported the dollar’s interest rate advantage, though gains were limited as equity market strength reduced safe-haven demand. The December manufacturing activity gauge came in at 51.8, matching consensus expectations precisely.

The currency landscape reveals deeper structural headwinds facing dollar bulls. Market pricing now reflects only a 15% probability of a -25 basis point rate reduction when the Federal Reserve convenes January 27-28. Looking ahead to 2026, expectations show the Fed potentially cutting by approximately -50 bp while the Bank of Japan is projected to raise rates by another +25 bp and the European Central Bank expected to maintain its current stance. This divergence matters significantly when considering major pairs like the 100 billion yen to USD conversion rates and broader emerging market dynamics.

Dovish Fed Leadership Concerns

An emerging concern for dollar strength stems from speculation that President Trump will appoint a monetary policy dove to lead the Federal Reserve in early 2026. According to Bloomberg reporting, National Economic Council Director Kevin Hassett ranks as the frontrunner for the position and is widely viewed by financial markets as the most accommodative candidate. Such an appointment would likely undermine the greenback’s longer-term appeal.

Compounding these pressures, the Fed initiated a $40 billion monthly Treasury bill purchasing program in mid-December, effectively boosting financial system liquidity. This accommodation contrasts sharply with tighter monetary conditions elsewhere globally.

Euro Under Pressure from Mixed Signals

EUR/USD tumbled to a 1.5-week trough on Friday, finishing down -0.22% amid renewed dollar strength. Eurozone December manufacturing data disappointed, with the PMI revised downward -0.4 points to 48.4 from the previously reported 49.2. Simultaneously, November M3 money supply expanded +3.0% year-over-year, exceeding the +2.7% forecast and marking the highest pace in four months. Derivatives markets are currently pricing zero probability of a European Central Bank rate hike when officials meet February 5.

Japanese Yen Slides Despite Thin Trading

The Japanese yen depreciated to a 1.5-week low versus the dollar on Friday as elevated Treasury yields worked against the currency. Holiday closures in Japan resulted in below-average trading volumes. Markets are assigning zero odds to a Bank of Japan rate increase at the next gathering on January 23.

Precious Metals Caught Between Competing Forces

Futures markets displayed divergent momentum Friday, with February gold settling down -11.50 points (-0.26%) while March silver gained +0.412 (+0.58%). Headwinds included strengthening dollar valuations and higher global bond yield levels, both traditionally negative for bullion. An additional constraint stems from margin requirement increases—the CME raised precious metals margins for the second time within seven days, forcing traders to deploy additional capital and triggering some forced liquidations.

Supporting factors remain substantial. Central bank accumulation activity continues providing underpinning, particularly China’s People’s Bank, which expanded its gold reserves by +30,000 ounces to 74.1 million troy ounces in November—the thirteenth consecutive monthly increase. Global central bank gold purchases reached 220 metric tonnes during the third quarter, representing a +28% increase from the second quarter, according to World Gold Council data.

Investment flows remain constructive, with gold ETF long positions reaching a 3.25-year high on Tuesday, and silver ETF holdings climbing to a 3.5-year peak that same day. Geopolitical uncertainty surrounding tariff policy and regional tensions in Ukraine, the Middle East, and Venezuela maintains safe-haven demand. Additionally, anticipation of easier monetary accommodation from a potentially dovish Fed leadership continues supporting the precious metals complex as a store of value, particularly given the recent Federal Reserve liquidity injections.