Next week, the market will focus on US PCE inflation and PMI data. If these figures show persistent inflation and a strong economy, it will dampen expectations of interest rate cuts and benefit the US dollar. While the Bank of Japan is expected to hold rates steady, political instability is weighing on the yen, postponing the prospect of a rate hike until July. Weak UK data could increase the probability of a rate hike, putting pressure on the pound. The Reserve Bank of Australia still faces the possibility of a rate hike, with employment data being key.

"Interest rate cuts haven't even started yet, but expectations are already receding": Why is the US dollar getting stronger despite pressure?

The foreign exchange market has recently been revolving around a core question: when will major central banks truly shift towards easing? Despite reports of a possible change in the US president and even media reports of a criminal investigation against the current Federal Reserve chairman, the dollar has not only not fallen, but has outperformed most non-US currencies for the second consecutive week. This seemingly abnormal phenomenon actually has a clear underlying logic—traders are not really concerned about "who becomes chairman," but rather whether policy will change as a result.

The reality is that regardless of how the political turmoil unfolds, the likelihood of the Federal Reserve significantly shifting towards interest rate cuts in the short term is extremely low. The Consumer Price Index (CPI) released in December showed that both overall and core inflation remained stable at 2.7% and 2.6% year-on-year, respectively, without further decline; more worryingly, the Producer Price Index (PPI) showed signs of accelerating again. This indicates that inflation remains "sticky," and price pressures have not subsided as quickly as the market expected. Against this backdrop, traders' expectations for the pace of interest rate cuts this year have not eased significantly. Currently, federal funds futures still imply a cumulative rate cut of approximately 54 basis points by the end of the year, equivalent to two 25-basis-point rate cuts already priced in. However, the problem is that the Fed's latest "dot plot" only points to one rate cut. This means that the market is moving faster and further than the official figures.

If subsequent data continues to show strong economic resilience, this expectation gap could be corrected. Whenever the market begins to question whether two rate cuts were too much, short-term US Treasury yields tend to rise, supporting the dollar. Analysts note that recent non-farm payroll reports have not shown significant weakness, and the labor market remains tight; the Atlanta Fed's GDPNow model even predicts that the US economy will grow at an annualized rate of 5.3% in the fourth quarter of 2025. Against this backdrop of growth, if inflation remains high, the Fed has no reason to rush into rate cuts. On the contrary, the combination of "good growth and strong inflation" will reduce the necessity for aggressive easing, thereby strengthening the dollar's relative advantage.

Key data points emerge one after another: potentially revealing the "real story".

The coming week will see two highly sensitive data releases that could potentially ignite a break in the current stalemate. First is the Personal Consumption Expenditures Price Index (PCE) released on Thursday (January 22nd), the Federal Reserve's most closely watched inflation indicator. If the PCE continues to show that price declines are stalled, or even rebound slightly, market optimism regarding two rate cuts before the end of the year will likely be dampened. At that point, interest rate futures may lower their bets on rate cuts, pushing up short-term Treasury yields and directly benefiting the US dollar.

Another key focus is the preliminary S&P Global Purchasing Managers' Index (PMI) for January, released on Friday. This data effectively reflects the true state of economic activity. If both the manufacturing and services PMIs strengthen, it will further validate the resilience of the US economy, fueling talk of a "soft landing" or even a "no landing." This would mean the macroeconomic combination of "high growth + sticky inflation" would again limit the scope for interest rate cuts, and the US Treasury yield curve might face a rebalancing process of "postponing the timing of rate cuts and narrowing their magnitude." Conversely, if the PMI unexpectedly weakens, coupled with clear downward signals in inflation, the market is expected to revise its probability of rate cuts upwards, potentially putting pressure on the US dollar.

Furthermore, the US president may announce the next Federal Reserve chairman around the end of this month, adding another layer of uncertainty to the market. While the new candidate will not change current monetary policy in the short term, their policy inclination will influence expectations about the path of interest rates over the next few years. A hawkish candidate could exacerbate market volatility, while a dovish one might offer a brief respite. This "policy style premium," though not directly affecting today's decisions, is enough to amplify the volatility of interest rate expectations, which in turn can be transmitted to exchange rate fluctuations.

The Japanese Yen's Dilemma and the British Pound's Struggles: Non-US Currencies Each Have Their Own Troubles

While the US dollar remains strong, other major currencies are struggling. The Bank of Japan will announce its first policy decision of 2026 on Friday. Although the bank decisively raised interest rates by 25 basis points last December, pushing rates to a near 30-year high and expressing its willingness to continue tightening, recent political turmoil in Japan—with escalating rumors of a snap election—has put heavy pressure on the yen.

There are two reasons: First, early elections are often accompanied by expectations of fiscal expansion, and the government may increase spending to win public support, which would increase the supply of government bonds and push up term premiums. Second, the policy environment is becoming increasingly uncertain, and central banks usually choose to wait and see as elections approach, forcing the market to postpone its judgment on the timing of the next interest rate hike. Currently, overnight index swaps indicate that the next interest rate hike is more likely to occur in July, rather than the previously expected spring. The continued depreciation of the yen has also sparked speculation about central bank intervention, with the Finance Minister issuing multiple warnings. However, historical experience shows that verbal intervention or buying yen in the market can only produce short-term effects. The real turning point still depends on improvements in fundamentals and a reversal of the policy interest rate differential—that is, whether the Bank of Japan can firmly push forward with interest rate hikes, narrow the interest rate gap with the United States, and prevent secondary inflationary pressures from rising import costs.

In contrast, the situation in the UK is slightly more complex. The Bank of England cut interest rates by 25 basis points to 3.75% at its year-end 2025 meeting, the lowest level in nearly three years, with a 5-4 vote indicating significant internal disagreement on further easing. Its latest statement emphasizes that the "easy parts" of the rate-cutting cycle are over, and every step forward will require stronger evidence, particularly a marked slowdown in wage growth and a sustained decline in inflation.

Next week, the UK will see a series of key data releases: November employment figures on Tuesday, CPI and PPI on Wednesday, and December retail sales and preliminary January PMI figures on Friday. If these data collectively point to cooling inflation and easing wage pressures, the market may raise its expectations for interest rate cuts throughout the year, putting downward pressure on the pound, especially in cross-currency pairs against the euro. Meanwhile, in the Eurozone, the market generally expects the European Central Bank to remain on hold for the rest of the year, given its recent repeated emphasis on being in a "proper position." This stance is gradually shifting interest rate expectations between the Eurozone and the UK towards the euro, providing some support for the euro.

Australian dollar leads commodity currencies

Among commodity currencies, the Reserve Bank of Australia (RBA) is one of the few major central banks still discussing the possibility of interest rate hikes, which has allowed the Australian dollar to move independently over the past two months. Since November 21, the Australian dollar has maintained an upward trend against the US dollar, reflecting a market reassessment of its monetary policy outlook. Currently, overnight index swaps indicate a roughly 25% probability of a 25 basis point rate hike at the February 3 meeting, with all potential rate hikes by August already fully priced in. This divergence in policy expectations from the Federal Reserve is the core driving force supporting the Australian dollar.

Thursday's Australian employment report will be a key catalyst. Strong data will further solidify the market consensus that the Reserve Bank of Australia will eventually raise interest rates, pushing the Australian dollar higher. Conversely, if the job market shows signs of weakness, it could raise questions about the path of interest rate hikes, causing the Australian dollar to quickly retreat.

Overall, the market's main focus in the coming week will remain on the core contradiction of whether inflation is persistent enough and whether growth is strong enough. Given that the Fed's two rate cuts have already been widely priced in, any data deviating from expectations could trigger asymmetric and volatile price swings.