Dollar Starts Strong Against European Currencies, Aiming for the Yen and Commodity Currencies

The Dollar Index has commenced the new year with noticeable strength. This rise has significantly impacted the Sterling, Euro, and Swiss Franc due to Europe's sluggish economic outlook and ongoing concerns regarding the new US tariffs. However, while the Dollar shows robustness against these currencies, its performance against others, such as the Yen and various commodity-linked currencies, has been relatively subdued. The combination of stabilizing US Treasury yields and a resilient risk sentiment has capped the Dollar's upward movement.

The strength of the Dollar can be attributed to shifting expectations regarding interest rates in the US. Recent economic indicators suggest that the Federal Reserve is likely to implement fewer rate cuts in the upcoming year, thus providing ongoing support for the Dollar. In contrast, Europe is facing a more challenging economic climate, with political uncertainties contributing to potential risks. This divergence in economic fundamentals could lead to a widening gap in interest rates between the Federal Reserve and European central banks, creating additional headwinds for European currencies.

In an unexpected turn, the Yen has emerged as the strongest performer recently. Its strength appears to be a result of heavy selling pressure on other major currencies. Nevertheless, the Yen remains at risk in the medium term due to the Bank of Japan's cautious approach toward interest rate increases. As US yields begin to rise again, the Yen may soon face renewed downward pressure against the Dollar.

Commodity currencies, including the Australian Dollar, New Zealand Dollar, and Canadian Dollar, have shown some recovery. However, this resurgence represents a correction from significant losses in December rather than a fundamental shift. The Australian and New Zealand Dollars might experience renewed weakness if the situation in Chinese markets worsens, particularly since China's shaky start to the year has already affected investor confidence.

US Dollar Strength in 2025 Linked to Fed Policy Expectations

The Dollar Index started 2025 on a solid note, gaining substantial ground as traders anticipate a more measured easing approach from the Federal Reserve. Recent US economic data, which indicates resilience and moderately ongoing inflation risks, has solidified the belief that the Fed might decide on fewer rate cuts than previously expected.

This sentiment has been further bolstered by expectations surrounding potential pro-growth measures from the incoming Trump administration, which could enhance economic activity and inflate pressures. Current futures for the Fed funds suggest a nearly 90% probability that rates will stay between 4.25% and 4.50% this month, with an 85% chance of only one additional cut for the year, bringing rates down to 4.00% to 4.25%. Meanwhile, the European Central Bank (ECB) is anticipated to make more significant cuts, potentially lowering rates by as much as 100 basis points this year. This stark difference in central bank policies has lifted the Dollar’s appeal in the market.

Technically, the Dollar Index has demonstrated renewed momentum, rising from 100.15 to a peak of 109.53 as indicated by the MACD. The outlook remains bullish as long as the support level of 107.73 holds, with a next target at 110.31.

Looking at the broader picture, opinions vary regarding the price actions since the peak of 114.77 in 2022. It remains uncertain whether the corrective pattern from that high has fully concluded or if further declines will occur. However, maintaining trade above the 61.8% retracement level at 108.96 could set the stage for a retest of the 114.77 mark as the year progresses.

US equity markets have reacted positively to these adjusted Fed expectations, with the S&P 500 recognized as consolidating, maintaining an overall uptrend with resistance at 5669.67 now treated as support. Further gains through the resistance level of 6099.97 are anticipated upon completion of these consolidations.

Nonetheless, if risk-taking sentiment within stock markets increases, it may limit the Dollar Index’s upward potential, particularly above the immediate 110.31 target.

Yen: Resilient Yet Vulnerable

While the Yen showed resilience recently, it lacks the momentum needed for a sustainable rebound. The currency remains vulnerable to further depreciation, particularly depending on how the Bank of Japan (BoJ) handles rate hikes and the direction of US Treasury yields.

The BoJ is expected to continue with gradual rate increases, despite Governor Kazuo Ueda warning about global economic uncertainties, particularly with the new US policies. This cautious approach may lead to hesitation in raising rates, making a hike this January less certain.

Market sentiment appears to suggest that the BoJ might implement two to three rate hikes within this year, potentially reaching a milestone rate of 1.00%, a level not seen in decades. However, such adjustments would likely reflect normalization rather than aggressive tightening, which may not bolster the Yen significantly.

On a technical front, US 10-year yields have shown some resistance, with a rally pending as long as support at 4.484 holds. A decisive increase beyond 4.683 may add upward traction, while a drop below 4.484 could prompt a deeper correction.

The outlook for USD/JPY appears complex, with its next move closely tied to the trajectory of US 10-year yields. An increase from 139.57 could extend to a projection of 159.25 if yields rise. However, Japan's intervention stance will play a crucial role in determining if USD/JPY can surpass the 161.94 high.

Commodity Currencies: Fragile Amid Challenges in China

Commodity currencies have shown some resilience, primarily due to significant selling in European currencies. Yet there remains a high level of vulnerability moving forward, especially for the Australian and New Zealand Dollars.

The main concern is about the underperformance in Chinese markets at the beginning of the year. Chinese stocks started 2025 with significant losses, marking one of the worst annual openings in nearly a decade, raising worries around investor sentiment despite previous gains.

This cautious sentiment seems contradictory considering recent stimulus signals from Beijing. However, market participants remain doubtful about the speed and effectiveness of these measures, with significant policy actions potentially not coming until the legislative “Two Sessions” in March.

Moreover, domestic deflation forms part of the ongoing concerns, while the threat of US tariffs continues to loom over China’s economy and, consequently, the commodity currencies tied to it.

Technically, the Shanghai SSE composite index has exhibited concerning declines, with risks remaining heavily skewed to the downside unless it breaks past the 55-day EMA at 3306.79. The focus is now on key support levels around 3152.82 and 3174.26. A decisive drop below these levels could accelerate downward trends further.

Additionally, the Chinese Yuan is facing increased downward pressure, potentially breaking records as it continues to slide. While the government might support this depreciation as a tactic against escalating tariffs from the US, investor reactions remain uncertain.

Technically, USD/CNH is likely to continue its upward trend as long as support at 7.2842 holds, with a decisive break at 7.3745 potentially resuming the upward movement from previous lows.

The Australian Dollar (AUD/USD) is currently in a precarious position, with risk remaining to the downside unless the 0.6273 resistance holds. A significant break below 0.6169 confirms a broader downtrend. Conversely, a breakout above 0.6273 could initiate a short-term rebound.

For the New Zealand Dollar (NZD/USD), risks will also remain to the downside, especially if the 0.5671 resistance holds steady. A drop below 0.5511 would open pathways for further declines within projections.

EUR/USD Weekly Outlook

The EUR/USD pair's downward trajectory resumed, breaking through the support level of 1.0330 last week. A temporary low may have formed at 1.0223, leading to an initial neutral bias this week. However, declines are still anticipated as long as resistance at 1.0457 holds. A further break of 1.0223 could target a 61.8% projection level around 1.0083.

In the longer term, the decline from 1.1274 indicates that this pattern could imply either a corrective leg from 0.9534 or another step down within a longer-term downtrend. Sustained breaks below 1.0199 could signal deeper corrections back to the 0.9534 low. Currently, the outlook remains bearish as long as resistance at 1.0629 holds, even during strong rebounds.

From a broader view, the downtrend from 1.6039 continues with the EUR/USD pair remaining inside a downward channel, showing resistance at 1.0973. This suggests that while consolidation from 0.9534 may continue, further declines seem more likely as long as resistance persists at 1.1274.

Dollar, Yen, Commodities