Dollar Strengthens as Hawkish Fed Rhetoric Offsets Independence Concerns

The greenback gained ground on Tuesday with the dollar index (DXY) climbing +0.26%, primarily driven by weakness in the Japanese yen which tumbled to a 1.5-year low against the US currency. This dollar appreciation was reinforced by hawkish monetary policy signals from Federal Reserve officials, particularly St. Louis Fed President Alberto Musalem’s comments asserting the US economy remains robust with above-potential growth prospects ahead.

Mixed Economic Data Caps Dollar Rally

Tuesday’s economic releases presented a nuanced picture for the currency. US October new home sales came in stronger than anticipated at 737,000 units, down just -0.1% month-over-month, providing support for dollar bulls. However, December consumer price inflation data muddied the narrative. Core CPI remained flat month-over-month at +2.6% year-over-year, undershooting expectations of +2.7% y/y, while headline inflation held steady at +2.7% y/y. This softer-than-expected inflation reading introduced dovish considerations for monetary policy expectations, creating headwinds for the dollar’s advance.

Fed Independence Questions Cloud Market Sentiment

Despite hawkish commentary from Fed officials, underlying dollar momentum faced headwinds from concerns about Federal Reserve autonomy. Fed Chair Powell’s statements regarding Department of Justice investigation threats related to the institution’s building renovations raised questions about political interference in monetary policy decisions. Such concerns, stemming from perceived pressure to maintain lower interest rates, have introduced uncertainty that limits dollar upside potential.

Rate Cut Expectations and Currency Dynamics

Market pricing now reflects only a 3% probability of a -25 basis point rate reduction at the upcoming January 27-28 FOMC meeting. Looking further ahead, swaps suggest the Fed may deliver approximately -50 basis points of cuts during 2026, while the Bank of Japan is anticipated to raise rates by +25 basis points and the ECB is expected to maintain its current policy stance. These divergent rate paths typically support the dollar, though uncertainty about a potential dovish Fed Chair appointment in early 2026 creates counterbalancing pressure.

Yen Plunges Amid Political Uncertainty and Geopolitical Tensions

The USD/JPY pair surged +0.61% as the yen weakened to a 1.5-year low. Reports that Japanese Prime Minister Takaichi may dissolve parliament and call snap elections for February heightened concerns about sustained expansionary fiscal policy if the ruling party secures re-election. Additionally, escalating China-Japan tensions—including Chinese export restrictions on items with potential military applications in retaliation for Taiwan-related comments—have weighed on the yen. Markets are pricing zero probability of a BOJ rate hike at the January 23 meeting.

Euro Modest Losses Amid Dollar Strength

The EUR/USD pair retreated -0.16% as the euro felt pressure from broad-based dollar strength. The pair’s movement remained tempered by lingering concerns over Fed independence, which limited more aggressive dollar appreciation and provided some support for the common currency.

Precious Metals Navigate Competing Crosscurrents

Gold and silver prices delivered mixed results. February COMEX gold (GCG26) closed down -15.60 points (-0.34%), retreating from earlier contract highs after the dollar strengthened and following hawkish commentary from Fed officials cautioning against accommodative policy. March silver (SIH26), meanwhile, closed up +1.247 points (+1.47%), with the January contract setting a new nearest-futures record high of $88.61 per troy ounce.

Several factors are supporting precious metals prices despite near-term headwinds. December’s weaker-than-expected core CPI reading provides dovish impetus for gold and silver. Safe-haven demand has strengthened amid concerns about Federal Reserve independence and potential political influence on monetary decisions. Additionally, the Fed’s $40 billion monthly Treasury bill purchases—ongoing since mid-December—are injecting liquidity into financial markets, which historically supports precious metals as inflation hedges.

Central bank demand remains robust. China’s People’s Bank added 30,000 ounces to its gold reserves in December, bringing total holdings to 74.15 million troy ounces—marking the fourteenth consecutive month of reserve accumulation. The World Gold Council reported that global central banks purchased 220 metric tons of gold in Q3, up +28% compared to Q2 levels.

Fund positioning suggests sustained bullish sentiment. Long positions in gold ETFs climbed to a 3.25-year high on Monday, while silver ETF long holdings reached a 3.5-year high on December 23. Broader support comes from concerns that the Trump administration’s housing stimulus program—directing Fannie Mae and Freddie Mac to purchase $200 billion in mortgage bonds—represents quasi-quantitative easing, boosting demand for precious metals as value stores. Geopolitical uncertainties surrounding Iran, Ukraine, the Middle East, and Venezuela also underpin safe-haven demand.