The dollar is poised for its worst week since June as unpredictable US policymaking weighed on the currency ahead of next week’s Federal Reserve meeting.
The Bloomberg Dollar Spot Index fell to a three-week low on Friday and is down 0.9% on the week, making it the biggest drop in nearly seven months. Options traders are now paying a premium to hedge against further dollar losses over the next month — a sharp reversal from a week ago when bullish sentiment on the greenback was the highest since November.
Meanwhile, the yen advanced sharply versus the dollar, revealing that traders are on edge about the risk of Japanese authorities intervening.
Investors were whipsawed this week as US President Donald Trump first brandished tariffs on Europe over his bid for Greenland, then abruptly dropped them after striking a deal with NATO Secretary General Mark Rutte at the World Economic Forum in Davos. The fact that the greenback is sliding — even as US Treasury yields rise on bets that a resilient economy will keep the Fed on hold — suggests political risks are a bigger factor for the currency than monetary policy.
“The distribution of 2026 returns for the dollar must almost certainly be heavily-skewed to the downside at this point,” Brent Donnelly, the president of Spectra Markets and a former currency trader, wrote in a note. “The world is realizing that the US policy nightmare is not over.”
The Japanese yen rose as much as 0.7%, touching 157.37 per US dollar Friday, after the Bank of Japan kept interest rates unchanged, avoiding signals on the hike path. Finance Minister Satsuki Katayama declined to answer when asked if Japan had intervened in the market, keeping investors in the dark regarding the moment of yen volatility. The currency pared its advance later in the session, trading near 158.20. The yen’s proximity to 160 matters because Japanese authorities had intervened when it traded above that level in 2024.
In the US, money markets favor two quarter-point interest rate cuts this year, and price in almost no chance of a move next week. One-week volatility, which captures the Fed policy decision on Jan. 28, slightly abated Friday after climbing a day earlier to its highest level in more than a month.
Risks around the central bank’s independence and expectations that Fed Chair Jerome Powell’s successor will be swayed by Trump to lower rates faster are also weighing on the dollar.
Trump said he has finished interviewing candidates and reiterated that he has someone in mind for the job. Trump has been highly critical of Powell for being too slow to lower borrowing costs.
“With policy volatility rising, the US dollar has become the release valve for US risk premia,” said Erica Camilleri, senior global macro analyst at Manulife Investment Management. “This explains why the dollar took a sharp reversal this week, despite markets pricing out further Fed cuts.”
Skewing Dollar Bearish
The US economy expanded in the third quarter at a revised 4.4% annualized rate, the fastest in two years, according to Bureau of Economic Analysis data out Thursday. Applications for US unemployment benefits were little changed last week, steadying at low levels after a volatile holiday season, according to recent Labor Department data. Initial claims increased by 1,000 to 200,000 in the week ended Jan. 17, while the median forecast in a Bloomberg survey of economists called for 209,000.
“US labor market optimism is not a threat to our moderately bearish dollar view just yet,” said Pat Locke, a New York-based FX strategist at JPMorgan. “US policy event risks also skew net dollar bearish over the next few weeks.”
The dollar gauge rose to its 200-day moving average last week before retreating. Since April, the moving average has acted as a major barrier that prevented the greenback from rebounding too far. The greenback briefly topped the moving average in November and earlier this month, before resuming its downtrend.
What Bloomberg Strategists say…
“The three-month correlation between the Bloomberg Dollar Spot Index and the S&P 500 has now nearly dissipated again — supporting higher hedge ratios given weaker portfolio protection. Compelling alternatives abroad plus the return of tariffs as a coercive tool threaten to revive the same forces that led much of dollar’s decline last year.”
—Tatiana Darie, Macro Strategist, Markets Live.
Risk-sensitive currencies were outperforming peers in the Group of 10 this week, supported by the Trump’s U-turn on tariffs linked to his Greenland plan. The New Zealand dollar, Norwegian krone and Australian dollar advanced the most against the greenback in the last five days.
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