Weekly Forex Overview: Dollar Retreat and Central Bank Policies in Focus

Dollar Movement Influenced by Fed Rate Cut and T-Bill Purchases

The U.S. dollar experienced selling pressure last week, driven by the Federal Reserve’s decision to reduce interest rates and its increased Treasury bill purchases. Consequently, the Dollar Index declined for the fourth time in five weeks. Excluding the Bank of England—which is expected to cut rates imminently—the monetary easing cycles for most G10 central banks appear to have concluded. The Federal Reserve’s latest Summary of Economic Projections shows a median expectation of one rate cut next year, while the market, perhaps factoring in upcoming leadership changes, anticipates at least two. This divergence in monetary policy path has underpinned a bearish outlook on the dollar. However, momentum indicators suggest that the dollar’s recent decline is overextended short-term, signaling a likely phase of consolidation.

Central Bank Meetings on the Horizon

This week features six G10 central bank meetings:

– **European Central Bank (ECB)**
– **Bank of England (BOE)**
– **Norway’s Norges Bank**
– **Sweden’s Riksbank**
– **Reserve Bank of New Zealand (RBNZ)**
– **Bank of Japan (BOJ)**

Most are expected to maintain current rates. Exceptions include the Bank of England, poised to cut rates, and the Bank of Japan, likely to raise them. Additionally, two Latin American central banks—Chile and Mexico—will convene, with both expected to cut rates and signal a pause afterward. The Czech National Bank will meet as well; its easing cycle ended in May and rate changes seem unlikely in the near term.

U.S. Economic Data and Market Dynamics

The U.S. economic calendar will catch up with November’s employment data, Consumer Price Index (CPI), and October retail sales, alongside preliminary December Purchasing Managers Index (PMI) releases across tracked economies.

Interest Rate Differentials and Outlook

The U.S. two-year Treasury premium over Germany narrowed to approximately 135 basis points, its lowest since September 2024, while the 10-year spread over Japan is close to 220 basis points, near its lowest level since April 2022. As the year closes, only the Federal Reserve and Bank of England appear likely to extend monetary easing candidacies into next year.

The narrowing trade deficit in Q3 2024 (approximately $207.3 billion vs. $231.3 billion in Q4 2023) seems driven more by tariff measures than exchange rate adjustments. The real broad trade-weighted dollar remains at the high end of its 40-year historical range, reflecting a broadly overvalued currency.

November Labor and Inflation Data Preview

Market consensus forecasts a modest nonfarm payroll increase of about 40,000 jobs for November, with the unemployment rate stable at 4.4%, the highest since October 2021. CPI headline inflation is projected to slightly surpass 3.0%, its first rise above this threshold since May 2024, with the year-over-year rate having not declined since April. Core inflation is anticipated to inch up to 3.1%, reversing a recent mild dip.

Retail sales for October are expected to be soft, with known factors including a sharp decline in auto sales following the expiration of electric vehicle subsidies and a nearly $2 billion deceleration in consumer credit.

Dollar Index Technical Levels

The Dollar Index closed near 98.15 last week, hovering just above the 61.8% Fibonacci retracement from the year’s September 17 low (~97.80). With market participants having absorbed recent developments, a corrective or consolidative phase may ensue. Resistance now clusters around 98.60 to 98.85, with trendline resistance near 98.70 by next week and trending toward 98.00 by year-end.

Eurozone: ECB Meeting and Currency Trends

Interest Rate Correlations

The 30-day rolling correlation between euro changes and U.S. two-year Treasury rates stands near -0.45. Similarly, changes in the euro relative to the U.S.-Germany two-year yield differential correlate at about -0.40. After an extended period of inverse correlation between the euro and German two-year yields from May through November, correlations have briefly turned positive, only to revert again recently. Regarding 10-year German yield influences, initial positive correlation at the start of 2024 has largely inverted since midyear.

Data and ECB Outlook

October industrial production estimates will be released but are likely to yield muted market reactions, given prior national data. The preliminary December PMI on December 16 holds higher potential for impact. The ECB meeting is the week’s focal point; no policy changes are expected, yet President Christine Lagarde’s press conference and the updated economic forecasts will serve as key forward guidance.

Euro Technical Levels

Supported partially by Federal Reserve developments, the euro briefly approached its 61.8% retracement of its decline from the September 17 peak but failed to close above $1.1750. Momentum indicators are stretched, suggesting consolidation or correction is likely. Initial support is identified around $1.1690-95, followed by $1.1640.

China: Yuan Appreciation and Policy Signals

Exchange Rate Management

The People’s Bank of China (PBOC) continues to guide the dollar lower against the yuan through daily reference rates. While some contend that China’s trade flows are sensitive to exchange rate shifts, current evidence suggests limited elasticity. Modest yuan appreciation may assist Beijing by alleviating trade frictions, enhancing purchasing power domestically, and benefiting Chinese enterprises engaged in outbound investment.

Reports indicate state-owned banks have been active in purchasing dollars despite official guidance. Furthermore, Beijing recently announced a licensing regime for steel exports effective January 1, targeting around 300 products, likely aimed at moderating record shipment volumes.

The Central Economic Work Conference’s messaging leaves open the possibility of easing monetary policy in the year ahead.

November Economic Data Preview

Data due on December 15 include retail sales, industrial production, capital investment, and property market updates (including new and used home prices). Retail sales and industrial output are expected to show slight year-over-year growth below 3% and around 5%, respectively. Capital investment contraction is forecast to deepen, reducing its GDP share while elevating consumption’s role. The property sector’s drag remains significant.

Yuan Price Action

The dollar closed just above CNH7.05 last week, a level not seen since October 2024, down more than 1% from four weeks prior. Resistance may emerge near CNH7.07 during a dollar consolidation phase. Market consensus suspects authorities are comfortable with the yuan trading near CNH7.0—its 2024 September bottom—with the yuan possibly returning toward CNH6.70 in 2026.

Japan: Rate Hike Expectations and Market Correlations

Market Dynamics

The conventional view that rising Japanese interest rates will prompt repatriation of funds neglects critical factors such as hedging strategies, exchange rate movements, and foreign investor behavior in Japan. Correlation analysis over 30- and 100-day periods reveals that dollar-yen movements are more closely linked to U.S. 10-year Treasury yields than Japanese Government Bonds (JGBs). Short-term (30-day) correlation with U.S. yields is approximately 0.30, significantly exceeding the less than 0.15 correlation with JGBs. Over the past 100 days, this divergence is even more pronounced.

Economic Data and BOJ Meeting Outlook

Several near-term high-frequency data releases—including the BOJ’s Tankan Survey and tertiary industry activity—are scheduled. Expectations are for minimal deviation from Q3 readings, with capital expenditure intentions and small business conditions remaining pressure points. Japan’s economy contracted at an annualized 2.0% in Q3 but shows signs of a stronger start to Q4. Industrial output increased 1.4% in October; tertiary activity rose 0.3% in September, the fastest pace since May.

November trade figures are anticipated to display seasonal deterioration. Despite an undervalued yen on multiple metrics, Japan continues to run a trade deficit averaging roughly JPY 307 billion per month in the first ten months of 2024, improving from 2023 but still substantial.

Inflation data from Tokyo show elevated yet stable conditions, with headline CPI at 2.7% and core measures near 2.8%. The role of rice prices remains notable.

Currency Technical Levels

The dollar stalled close to JPY157 last week before retreating slightly below JPY155 after the Fed rate cut. However, downward pressure on the yen appears limited as U.S. 10-year yields continue rising. Should the dollar break above JPY156.50, it may target a retest of late November’s high near JPY158. The market has largely priced in a BOJ rate hike at the upcoming meeting on December 19; failure to hike would potentially cause disruption.

Swaps markets currently anticipate one rate hike next year, likely in mid-Q3.

United Kingdom: Sterling Performance and BOE Rate Cut

Market Relationships

Sterling remains highly sensitive to dollar trends. The 30-day rolling correlation between sterling and the Dollar Index is about -0.80, a range sustained over four months. Given that the euro forms the largest component of the Dollar Index, sterling’s movement relative to the euro also matters; this correlation stands near +0.80, fluctuating between 0.65 and 0.92 on an annual basis.

Data and Policy Outlook

An important week is ahead for the UK, with Tuesday bringing the labor market update and preliminary December PMI. November CPI data will follow on Wednesday, preceding the Bank of England’s Thursday meeting, where the market widely expects a rate cut—the first since August. The swaps market indicates a strong chance of an additional cut in the first half of 2026 and about a 40% probability of another cut in the second half.

Retail sales for November will conclude the week, likely rebounding after a 1.1% drop in October.

Sterling Technical Levels

Sterling recently approached $1.3440—the highest since October 20—and near the 61.8% Fibonacci retracement of declines since September 17. Momentum indicators are stretched, suggesting possible consolidation ahead. Immediate support lies around $1.3340-45, with a break below $1.3300 raising the prospect of a deeper correction toward $1.3200. Sterling’s previous strength against the euro has recently waned.

Canada: Canadian Dollar Dynamics and Economic Data

Market Correlations

The Canadian dollar’s sensitivity to the overall dollar direction has decreased this year. The 30-day rolling correlation between USD/CAD changes and the Dollar Index peaked near 0.80 in August but has since declined near 0.35. There remains an inverse relationship between the Canadian dollar and S&P 500 changes, with a rolling correlation around -0.35.

Data and Bank of Canada Policy

The Bank of Canada kept rates unchanged last week, as widely anticipated, limiting immediate market reaction to upcoming data releases including November CPI, October portfolio flows, and retail sales. Markets are increasingly factoring in the possibility of a rate hike later in 2026, with about a 20% chance before midyear and around 90% likelihood by early Q4, according to swaps pricing. Bank of Canada Governor Macklem’s speech on December 16 may emphasize caution against premature financial tightening.

Technical Outlook

Following a midyear selloff, the U.S. dollar rallied against the Canadian dollar, reaching near CAD1.3800 before a renewed decline. The currency pair’s three-week U.S. dollar slide is its longest since April and momentum indicators suggest overextension. Potential support lies in the August–September range near CAD1.3725. A corrective phase could see the USD/CAD retrace toward the CAD1.3800–1.3825 region temporarily. Nonetheless, a break of the 2025 low near CAD1.3540 appears likely in early 2026, potentially targeting CAD1.3400.

Australia: Economic Growth and Currency Adjustments

Market and Policy Factors

The Australian dollar’s earlier three-week 4% rally stalled following disappointing November employment figures and juxtaposed with a hawkish RBA hold and the Fed rate cut. Futures contracts initially priced in a rate hike by mid-2025 but have since shifted expectations to mid-Q3 2026. The 30-day rolling inverse correlation between AUD and the Dollar Index is approximately -0.35, after briefly turning positive last month—the first time since early 2020. The AUD’s correlation versus USD/CAD is about -0.70, a three-month extreme.

Economic Data

The December preliminary PMI is the week’s highlight. The composite PMI was 52.6 in November, averaging 53.0 over the past six months—a level not seen since before the pandemic. Quarterly GDP growth was 0.4% in Q3 and forecasts indicate modest expansion (1.8% in 2024 and 1.9% in 2025).

Currency Technicals

The Australian dollar peaked near $0.6685 last week, slightly below its 2024 high just above $0.6700 from September 17. Momentum indicators are stretched, signaling mounting corrective pressure. A breach of $0.6625 would confirm correction risk, potentially pulling toward $0.6550, with intermittent support near $0.6585.

Mexico: Peso Strength Amid Regional Currency Dynamics

Drivers and Correlations

Recent yen recovery, partly linked to BOJ hike expectations and Fed cuts, was anticipated to weaken the peso via popular carry trades. However, the peso has instead risen to yearly highs. Notably, the Swiss franc and U.S. dollar remain competitive funding currencies, diluting yen-centric impacts. From late May to early October, the correlation between dollar moves against the yen and peso was positive, peaking near 0.75—the highest since May 2021—but recently shifted back toward negative territory.

Mexico’s Congress approved a new tariff regime last week targeting not only China but also countries using Chinese inputs for exports. This may increase domestic inflation but is likely aimed at fostering goodwill with the U.S. ahead of next year’s USMCA review, potentially securing tariff relief.

Data and Central Bank Actions

Following October retail sales data, Mexico’s central bank will announce its policy decision. Markets assign a strong probability to a 25 basis point rate cut, consistent across Bloomberg’s economists and derivatives pricing. This is expected to mark the last cut in the cycle.

Peso Technical Levels

The dollar fell to new yearly lows against the peso before the weekend, briefly dipping below MXN17.99. Despite sharp U.S. equity declines, the market remained optimistic, buoyed by surprisingly robust October industrial output (+0.7% vs. +0.1% forecast). Selling pressure eased, and the greenback finished above MXN18.01. Former resistance near MXN18.20-18.25 may now cap gains. A decisive break below MXN18.00 could open the way to MXN17.60.

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_This analysis is provided solely for informational purposes and does not constitute investment advice or recommendations._