Weekly FX Market Analysis: US Dollar and Major Currency Developments

US Dollar Overview

Last week, the US dollar largely consolidated against G10 currencies. This stability stemmed from solid economic data and the market’s dismissal of recent political efforts to sway Federal Reserve policy, which imparted a modestly firmer tone. Despite political noise, the Federal Reserve’s independence remained firmly supported by bipartisan consensus. Early volatility induced by subpoenas involving the Federal Reserve chair’s testimony was short-lived, with the derivatives market pricing in no rate changes until late Q2 at the earliest. While some financial institutions are revising their Fed outlooks for the year, market pricing still anticipates approximately two rate cuts in 2026, consistent with the December median dot projections.

Over the last 30 to 60 days, the correlation between changes in the US Dollar Index and two-year Treasury yields has weakened to roughly 0.38–0.40, near the lower bound of the past eight months.

Upcoming Data and Political Factors

This week’s data releases are unlikely to shift market positioning significantly, with headline risks limited given recent CPI and PPI data. November’s PCE deflator is expected to have marginal impact, whereas income and consumption figures will refine Q4 GDP forecasts. The preliminary January PMI report will follow, although market attention favors ISM data.

President Trump’s upcoming World Economic Forum remarks may introduce new policy initiatives, which markets should monitor closely.

Technical Outlook

The dollar has been recovering from its decline since last November (near 100.40) to the Christmas low (~97.75). It marginally exceeded the 61.8% Fibonacci retracement (~99.40) last week. Momentum indicators remain constructive but are increasingly stretched, suggesting potential minor additional gains before a possible reversal pattern emerges.

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Eurozone Currencies

Market Dynamics

Heightened tensions between the Trump administration and the Federal Reserve contributed to the euro finding support near the $1.1600 level. The widening US two-year Treasury yield premium—expanding from approximately 133 basis points to 147 basis points—has weighed on the euro. This premium represents the largest spread in about a month but remains below the 150 basis point threshold last seen in late November.

The euro’s inverse correlation with US two-year yields is stronger (-0.34) compared to its correlation with German two-year yields (close to zero).

Economic Data

Eurozone current account data for November will be released, reflecting a monthly average surplus around €26.4 billion through October, a quarter less than the previous year. Germany’s surplus narrowed by approximately 22% year-over-year across the first ten months of 2025.

The ECB anticipates the current account surplus to narrow from 2.7% of GDP in 2024 to 1.9% in 2025 and 1.7% over the following two years.

Germany’s ZEW survey, also scheduled for release, showed in December a five-month high in expectations (45.8) following a subdued 15.7 reading the prior year, while the current economic assessment declined to the lowest level since May (-81.0). The preliminary January PMI will be published at week’s end; December manufacturing and services PMIs stood at 48.8 and 52.4, respectively, with the composite just above the 50 expansion threshold.

Technical Perspective

The euro briefly dipped below $1.1585 last week, moving under the closely watched 200-day moving average near $1.1590 for the first time since March. Momentum indicators are stretched; a decisive break below this level could target the $1.1520 area, while regaining a foothold above $1.1650 would aid in stabilizing the euro’s technical outlook.

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Chinese Yuan and Monetary Policy

Policy Direction

Since April/May 2025, the People’s Bank of China (PBOC) has deliberately allowed gradual yuan appreciation by adjusting the dollar reference rate downward. Last week’s fix reached below CNY7.01 for the first time since May 2023, edging closer to the anticipated target of CNY7.00. This threshold permits the dollar to trade as low as CNY6.86 within the 2% trading band.

Despite December’s CPI rising to a three-year high, the strengthening yuan likely permits the PBOC scope to ease monetary policy to support economic growth.

Data and Market Reaction

Skepticism towards Chinese economic data persists, particularly regarding real sector figures such as GDP and current account reports. Nevertheless, metrics like foreign exchange settlements, fixed asset investment, trade surplus, and property market indicators are viewed with comparatively greater confidence.

Q4 GDP figures, due early this week, are expected to maintain growth near 1.1% quarter-over-quarter, consistent with approximately 5% year-over-year for 2025.

The offshore yuan weakened marginally to nearly CNH6.9610 before the weekend, its lowest since May 2023. Authorities appear intent on moderating the pace of yuan appreciation, anticipating a consolidation phase where the dollar may recover towards CNH6.98–6.99.

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Japanese Yen and Monetary Policy

Market Drivers

The relationship between the dollar-yen exchange rate and US 10-year Treasury yields, as measured by a rolling 30-day correlation, peaked near 0.80 in August 2025 but fell below 0.20 by late December, marking the lowest level since May. It has since recovered to around 0.45. Correlations with 10-year Japanese government bond yields remain modestly positive near 0.25.

Speculation about a snap election, possibly called by Prime Minister Takaichi next week, adds uncertainty to yen dynamics. Public support for the Prime Minister and cabinet remains high, but a strong electoral mandate is typically bearish for the yen.

Verbal intervention threats from Japanese officials have helped stabilize the currency, preventing further depreciation. The yen ended the week little changed after reaching its weakest level since July 2024.

Upcoming Data and Monetary Policy

The Bank of Japan is widely expected to maintain its current policy stance at its upcoming meeting. The market does not fully price a potential rate hike until July. Recent disappointing labor income data suggest easing inflationary pressures, with December CPI expected to soften relative to prior months.

November industrial output and tertiary sector activity data will provide additional insight, while December trade figures, typically improving seasonally, are due shortly.

Technical Review

The dollar approached JPY159.50 last week, levels not seen since July 2024. Intervention risks have kept the dollar below JPY158 ahead of the weekend. For a meaningful yen short squeeze, the dollar would likely need to drop beneath the JPY157.40–157.00 range.

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United Kingdom Sterling

Market Behavior

Sterling’s sensitivity to dollar movements has increased, reflected in a near-term 30-day rolling correlation of around -0.85 with the Dollar Index, one of the most pronounced since October. Correlations with US and UK two-year yields remain muted.

Data Highlights

This week is significant for UK economic releases, including labor market statistics, CPI, and retail sales. Market expectations lean toward the Bank of England maintaining a pause in rate adjustments until at least Q2, tempering the immediate impact of these releases.

UK CPI remains one of the highest in the G10 at 3.2% (November), while the unemployment rate at 5.1% (October) is among the highest too. Budget data due on January 22 may attract attention amid political developments affecting the Labour Party and Prime Minister Starmer.

The composite PMI ended 2025 at 51.4, slightly above the 50 expansion threshold but showing a moderate slowdown from previous years.

Price Action

Despite stronger-than-expected November GDP growth (0.3%), sterling weakened to its lowest level since late December, under $1.3365, before stabilizing ahead of the weekend. Momentum indicators are bearish, and a break below $1.3365 could open the door for further declines toward $1.3300.

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Canadian Dollar

Market Developments

The Canadian dollar showed limited response to trade agreements facilitating lower tariffs on Chinese electric vehicles and canola exports. The US dollar’s corrective phase from its November peak near CAD1.4130 paused but remains incomplete.

The Canadian dollar’s recent moves have closely tracked dollar strength, with a correlation of about 0.55 against the Dollar Index over 30 days—the highest in over two months.

Economic Outlook and Data

The Bank of Canada has acknowledged high uncertainty and signaled an extended pause, with the market pricing in a 60% chance of a rate hike by year-end.

Key upcoming releases include December CPI and November retail sales, alongside the Bank’s Q4 economic outlook. Inflation has averaged 2.0% year-over-year through November 2025, with core measures slightly firmer around 2.8%. Consumer spending has shown softness, with a contraction in Q3.

Technical Positioning

The US dollar stalled near the 61.8% Fibonacci retracement (~CAD1.3945) of its November 21 decline. After trading within a narrow range this week, a breakout toward CAD1.4000–1.4020 appears probable. Momentum suggests such a move could mark the culmination of the current leg higher.

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Australian Dollar

Market Momentum

The Australian dollar has started 2026 strongly, outperforming all G10 currencies against the US dollar so far. Over the past 30 sessions, its inverse correlation with the Dollar Index averages -0.45, lower than the robust -0.7 to -0.8 seen in Q3 2025.

The currency’s sensitivity to Australia’s two-year bond yields remains elevated, near 0.82—the strongest in four years.

Economic Data

Australia is due to release December employment figures, following a notable job loss of 56.5k full-time positions in November, the largest since late 2023. The unemployment rate increased to 4.3% in the first half of 2025 and has remained near this level.

The preliminary January PMI will follow, with the year-end composite PMI standing at 51.0 after a recent moderation.

Technical Analysis

The Australian dollar hovered above $0.6700 throughout last week but failed to close above it following a stall near $0.6730, just below the 61.8% retracement level (~$0.6765). Momentum indicators have weakened, with the five-day moving average crossing below the 20-day average. A break below $0.6650 could prompt a further decline of about half a cent.

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Mexican Peso and Latam Currencies

Market Drivers

Latin American currencies dominate emerging markets’ early 2026 performance, buoyed by relatively higher interest rates and, in some cases, commodity price exposure. The Mexican peso gained approximately 1.7%, ranking second behind the Colombian peso.

Carry trade flows appear instrumental in the peso’s resilience, complemented by perceptions it has managed US policy shifts more effectively than some peers.

Economic Data

Mexico will report November retail sales and the IGAE economic activity indicator, a monthly proxy for GDP. Retail sales in 2025 expanded at an average monthly rate of 0.3%, reversing the slight contraction seen in 2024.

The IGAE rose by 0.98% in October, the strongest month since July 2024, suggesting positive momentum.

H1 January CPI readings are forthcoming; headline inflation currently sits at 3.66%, with core inflation above the upper bound of the 2-4% target range.

Price Levels

The peso strengthened to levels last seen in July 2024, reaching approximately MXN17.62 before consolidating. Technical targets suggest support near MXN17.60, with downside risk toward MXN17.38 and MXN17.00. Resistance is clustered around MXN17.80–17.85.

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Disclaimer

This analysis is provided for informational purposes and does not constitute investment advice. Market conditions may change rapidly, and readers should conduct their own due diligence and consult with professional advisors before making financial decisions.