The dollar extended its decline in thin post-holiday trading on Friday as portfolio rebalancing and subdued liquidity magnified selling pressure, with market participants positioning aggressively for Federal Reserve policy easing in the first quarter of 2026. The greenback's broad-based weakness reflects growing conviction that the Fed's December meeting marked a definitive pivot toward accommodation, strategists say.
The Federal Reserve held its benchmark rate steady at its December 16-17 meeting, as widely expected, but subtle shifts in the dot plot projections and Chair Powell's emphasis on disinflationary progress have convinced traders that a cutting cycle looms. "The Fed effectively greenlit 2026 rate cuts without explicitly saying so," noted a senior currency trader at a major Wall Street bank. "Powell's commentary on the neutral rate and his willingness to look through short-term inflation noise was the real signal." Market-implied odds for a January rate reduction have surged in subsequent sessions, weighing on the dollar across major pairs.
Against the euro, the dollar tested multi-week lows as the single currency drew support from the European Central Bank's relatively measured December stance. The ECB cut rates by 25 basis points at its December 11 meeting but President Lagarde's pushback against aggressive easing expectations has created a widening policy divergence narrative. Sterling similarly gained ground, with the British pound benefiting from residual hawkishness at the Bank of England and better-than-expected November inflation data released earlier this month. In the yen complex, the dollar faced additional pressure as the Bank of Japan's December 18-19 meeting minutes, released Thursday, reinforced expectations for gradual policy normalization in 2026, with board members discussing wage growth momentum and sustainable inflation.
Commodity markets reflected the dollar's travails, with gold extending its recent rally to fresh multi-month highs as investors sought both currency hedges and safe-haven exposure amid persistent geopolitical tensions in the Middle East and ongoing trade friction between major economies. Crude oil held steady near recent ranges, with traders balancing OPEC+ production policy expectations against demand uncertainty heading into the new year. Bitcoin and broader crypto assets saw modest gains in holiday-thinned trading, though institutional participation remained subdued.
Looking ahead, market participants say the combination of year-end flows and early 2026 positioning will likely drive volatility through the remainder of December. "We're seeing classic portfolio rebalancing, but it's happening in a vacuum of liquidity," said a head of foreign-exchange trading at a European asset manager. "That creates outsized moves that may not reflect true fundamental shifts." Traders will watch for the January 3 nonfarm payrolls report and the subsequent FOMC meeting on January 28 for clarity on the Fed's policy trajectory. Technical analysts note that the dollar index has broken below its 200-day moving average, a development that could accelerate selling if sustained into the new year.
Disclaimer: This analysis is AI-generated for educational purposes. Traders should verify all information and conduct their own research before making trading decisions.