Dollar Soft Start in 2026 After 9.4% Fall Shakes FX

Dollar weakness enters 2026 with data and Fed leadership in focus

The U.S. dollar began 2026 on the back foot on Friday, Jan. 2, after a 2025 fall that left the dollar index at 98.186 and down 9.4% for the year, its biggest slide in eight years. The soft start matters because FX is trading off yields again, and next week’s U.S. labour data can reset rate expectations.

In early Asia trading, the euro at $1.1752 followed a 13.5% surge in 2025, while sterling held around $1.3473 after a 7.7% rise, both their strongest annual gains since 2017. With Japan and China closed for holidays, thin liquidity magnified moves after the year’s sharp dollar fall, and that puts 2026 volatility back in play for FX traders.

Yield spreads drive the next move as traders price 2026 cuts

The dollar’s decline tracked a narrowing gap between U.S. rates and those abroad, reducing the carry appeal of holding dollars. Traders have opened 2026 with two Fed cuts priced in 2026, versus one implied by the Fed’s latest projections, leaving short-dated Treasury yields sensitive to inflation and jobs prints.

If markets pull forward cuts, yields usually ease and the dollar tends to soften, which can lift risk assets through looser conditions. If inflation surprises to the upside, yields can firm and push the dollar higher, even if the 2026 story remains gradual easing.

Fed chair timing puts policy risk in play for the dollar

Fiscal deficit worries, the risk of a renewed global trade war, and questions about Federal Reserve independence have become part of the currency narrative. The next focal point is the Trump Fed chair pick May 2026, with Jerome Powell’s term ending in May 2026 and President Donald Trump expected to name a successor.

Goldman Sachs strategists said they expect independence concerns to extend into 2026 and see the leadership change as one reason risks around their policy-rate outlook skew dovish. For markets, that adds a premium to hedging because it widens the range of possible rate outcomes, even before any policy changes.

Euro and sterling strength feeds directly into European assets

A firmer euro can reduce imported inflation but also tighten conditions for exporters, particularly during Q4 earnings season when revenue translation becomes visible. EUR/USD near $1.1752 has also kept investors focused on whether Europe’s rate advantage holds if U.S. yields drift lower.

Sterling’s rise carries similar trade-offs. GBP/USD around $1.3473 can help cap inflation, but it can pressure overseas earnings translation for some UK-listed firms. For European equities, these FX levels influence margins and guidance.

The yen is still weak, and intervention risk still exists

Japan’s yen has been an outlier. USD/JPY was around 156.85, after the yen rose less than 1% in 2025 and stayed close to a 10-month low of 157.90, keeping the yen near 157.90 intervention risk in the background.

The Bank of Japan hiked rates twice in 2025, but the cautious pace disappointed investors and helped unwind speculative long-yen positions. Investors have also watched fiscal policy under Prime Minister Sanae Takaichi, where concern about expansion has added a risk premium that can keep the yen soft even as the dollar slips.

Traders have been pricing the next BOJ hike toward the end of 2026. ING senior economist Min Joo Kang has flagged October as a plausible timing and warned a larger fiscal push could backfire on growth, a condition that would keep USD/JPY volatile.

Aussie and kiwi gains reflect carry trades returning after the dollar fall

The Australian dollar rose about 0.35% to $0.66975 after nearly an 8% gain in 2025, its best year since 2020. The New Zealand dollar firmed to about $0.5761 after snapping a three-year losing streak with a near 3% annual rise.

These moves put carry and China-linked demand back in play for investors hunting yield and growth exposure. If U.S. yields drift lower, AUD and NZD can stay supported; if U.S. data firms and yields rise, these higher-beta currencies are often first to retrace.

How this FX setup shakes stocks, commodities, and credit

A softer dollar can support commodities, boost overseas earnings for U.S. multinationals, and ease funding pressure for emerging markets. It can also lift U.S. import prices at the margin, one reason Treasury yields do not always fall with the dollar.

For equities, the clearest beneficiaries are globally exposed sectors and firms with large non-U.S. revenue, while domestic rate-sensitive areas remain tied to the yield outlook. In credit, the key distinction is whether the dollar’s slide reflects orderly rate convergence, or rising fiscal and policy uncertainty, since the latter can widen risk premia even if the currency weakens.

What to watch next

U.S. payrolls and weekly jobless figures next week are the first trigger for whether the dollar’s soft start extends, because they can move short-dated yields. Any clearer signal on a Fed chair shortlist before May 2026 is a second trigger that could reprice the independence premium in FX. A BOJ shift that pulls the next hike forward from late 2026 would be a third trigger for USD/JPY and intervention risk. Early-January inflation readings in Europe and the UK will test whether euro and sterling strength holds.