Dollar Strengthens Ahead of Upcoming FOMC Meeting as Rate Cut Bets Cool Off

The US dollar surged to a one-month high on Friday, gaining +0.20%, as hawkish economic indicators and expectations of persistent Federal Reserve tightness continue to keep rate-cut bets at bay. The currency’s rally reflects a shift in market sentiment regarding monetary policy, with the FOMC meeting scheduled for January 27-28 looming as a key catalyst for currency moves.

Mixed Labor Data Supports Dollar Strength

The dollar found solid footing from Friday’s mixed employment report, which presented a nuanced picture of the US labor market. While December nonfarm payrolls increased by only +50,000—falling short of the +70,000 projection—the unemployment rate tightened to 4.4%, beating expectations of 4.5%. November figures were also revised downward to +56,000 from the initially reported +64,000.

More importantly, average hourly earnings accelerated to +3.8% year-over-year, surpassing forecasts of +3.6%. This wage growth confluence reinforces inflation persistence and strengthens the case for the Fed maintaining its current stance, weighing against rate cuts in the near term. Market pricing reflects this outlook, with swaps pricing only a 5% probability of a -25 basis point cut at the forthcoming FOMC meeting.

Consumer Sentiment and Inflation Expectations Rise

The University of Michigan’s January consumer sentiment index jumped to 54.0, exceeding expectations of 53.5. However, inflation expectations painted a more troubling picture: the one-year inflation projection held steady at 4.2% compared to December, while the five-to-ten-year expectation ticked higher to 3.4% from 3.2%, both above initial forecasts.

These readings reinforce the narrative that price pressures remain elevated despite some moderation in economic activity. Atlanta Fed President Raphael Bostic echoed this concern during Friday commentary, stating that “inflation is too high, and we have to make sure that we don’t lose sight of the fact that even as labor markets have gotten cooler and more people are expressing concerns, we still have this big concern around inflation.” His remarks carried a hawkish tone that ultimately supported dollar positioning.

Housing Weakness Contrasts with Optimistic Forecasts

October housing data delivered unexpected weakness. Housing starts plummeted -4.6% month-over-month to a 5.5-year low of 1.246 million units, well below expectations of 1.330 million. Building permits, a forward-looking gauge of construction activity, fell -0.2% to 1.412 million, though this marginally beat forecasts of 1.350 million.

This divergence highlights uneven economic strength, though bond-purchase initiatives announced by the administration aim to address housing demand constraints.

The Monetary Policy Backdrop

Looking beyond the FOMC meeting on the immediate calendar, markets are pricing in approximately -50 basis points of rate cuts throughout 2026. Simultaneously, the Bank of Japan is expected to raise rates by +25 basis points in 2026, while the European Central Bank is forecast to maintain steady rates. This policy divergence continues to underpin dollar demand against other G10 currencies.

Further supporting greenback strength, the Federal Reserve commenced a $40 billion monthly Treasury bill purchase program in mid-December to boost liquidity—a factor that typically props up the dollar despite its counterintuitive nature in creating monetary ease.

One looming risk for the dollar involves potential dovish Fed Chair appointments. Markets believe incoming leadership may favor accommodation, a scenario that would prove bearish for the currency. Bloomberg reported that National Economic Council Director Kevin Hassett emerges as the leading candidate for the role, viewed by markets as the most dovish option.

Euro Pressure Contained by Eurozone Resilience

The EUR/USD pair declined to a one-month low, finishing -0.21% lower as dollar strength weighed on the euro. However, downside proved limited after Eurozone retail sales advanced +0.2% month-over-month in November, exceeding the +0.1% forecast. German industrial production surprised to the upside, rising +0.8% month-over-month against expectations of -0.7%.

ECB Governing Council member Dimitar Radev suggested the current interest rate environment remains “appropriate,” signaling comfort with the status quo. Market pricing implies a negligible 1% probability of a +25 basis point rate hike at the February 5 ECB decision.

Yen Tumbles on BOJ Stability Signal

The USD/JPY pair surged +0.66% as the yen declined to a one-year low versus the dollar. Bloomberg reported that the Bank of Japan will maintain rates at this month’s policy meeting despite upgrading economic growth projections. Concurrently, stronger dollar momentum and elevated US Treasury yields pressured the yen.

Political uncertainty added to yen headwinds. Reports indicated Prime Minister Takaichi may dissolve the lower house of the National Diet, creating fiscal and policy uncertainty. Separately, escalating China-Japan tensions—including Chinese export controls on Japan-destined materials—threaten supply chains and broader economic momentum.

Japan’s November leading economic index climbed +0.7 to a 1.5-year high of 110.5, precisely hitting expectations. Household spending rose +2.9% year-over-year, smashing the -1.0% forecast and marking the strongest six-month performance. Despite this bright spot, the yen remains undercut by rising defense expenditures, as Japan’s cabinet approved a record 122.3 trillion-yen ($780 billion) budget prioritizing defense spending increases.

Precious Metals Rally Despite Dollar Headwinds

February COMEX gold futures closed +40.20 (+0.90%), while March COMEX silver contracts surged +4.197 (+5.59%). The metals rally drew support from the administration’s announcement directing Fannie Mae and Freddie Mac to purchase $200 billion in mortgage bonds—a quasi-quantitative easing move that historically benefits hard assets as store-of-value alternatives.

Safe-haven demand persisted amid ongoing geopolitical uncertainties spanning Ukraine, the Middle East, and Venezuela, alongside lingering questions surrounding US tariff policy ahead of Supreme Court deliberations scheduled for next Wednesday. The Court’s ruling on tariff legality could alter currency dynamics significantly, as tariff elimination would expand budget deficits and potentially weaken the dollar.

However, headwinds emerged as the dollar index reached four-week highs and the S&P 500 climbed to record levels, both reducing haven appeal for precious metals. Citigroup projects potential outflows of $6.8 billion from gold futures and comparable silver outflows over the coming week due to reweighting of major commodity indexes including the BCOM and S&P GCSI.

Central bank demand remained a bright spot, with China’s People’s Bank adding +30,000 ounces to reserves in December, now totaling 74.15 million troy ounces. This marked the fourteenth consecutive month of Chinese reserve accumulation. Globally, central banks purchased 220 million tonnes of gold during the third quarter, representing a +28% increase from Q2 levels.

Fund positioning also contributed to support, as gold ETF long holdings climbed to a 3.25-year high Thursday, while silver ETF longs reached a 3.5-year high in late December, suggesting institutional conviction on the precious metals outlook.