The US dollar started 2026 weakly! Multiple risk factors may exacerbate the decline

The Zhitong Finance App notes that after experiencing last year's decline against most currencies, the US dollar ushered in a weak start to 2026 on Friday; at the same time, the yen stabilized near a 10-month low as traders waited for economic data to predict the interest rate trends of central banks this year.

Last year, the narrowing of interest spreads between the US and other economies overshadowed the market, causing most currencies to rise sharply against the US dollar, with the exception of the yen. Concerns about the US fiscal deficit, the global trade war, and the independence of the Federal Reserve have hit the dollar hard, and these problems are likely to continue until 2026.

On the first trading day of the year, the EUR/USD exchange rate stabilized at $1.1752, and the currency surged 13.5% last year; GBP/USD finally reported at $1.3473, which remained stable after rising 7.7% in 2025. Both the euro and the pound recorded their biggest yearly gains since 2017.

Prices did not fluctuate much as the Japanese and Chinese markets were closed on Friday.

The dollar's dominance weakens

The US dollar index, which measures the exchange rate of the US dollar against six major currencies, is reported at 98.186. The index recorded a 9.4% decline in 2025, the biggest annual decline in eight years.

Kyle Rodda, senior market analyst at Capital.com, said: “We've seen the peak of the dollar's hegemony. Despite this, the US dollar index has not experienced two consecutive years of decline in the past 20 years.” “I think the claim that the dollar is collapsing is exaggerated. The relative strength of the US economy means we will see it rebound this year.”

Economic data, including the number of non-farm payrolls and the number of unemployed people in the US, will be released next week. At that time, it will provide clues about the health of the labor market and the end of the Federal Reserve's policy interest rate this year.

The focus at the beginning of this year was mainly on who US President Donald Trump will choose to serve as the next Federal Reserve Chairman since current Chairman Jerome Powell's term ends in May.

Since the president has repeatedly criticized Powell and the Federal Reserve for not cutting interest rates more quickly and drastically, investors are preparing to welcome Trump's selection of a more “dovish” candidate who will push for interest rate cuts. Currently, traders expect to cut interest rates twice this year, while the currently divided US Federal Reserve Board predicts only once.

A Goldman Sachs strategist said, “We expect concerns about central bank independence to continue into 2026. We believe the upcoming change in the leadership of the Federal Reserve is one of several reasons why our federal funds rate predictions are dovish risk.”

The yen is still an exception

The yen exchange rate against the US dollar was 156.85. The yen rose less than 1% against the US dollar in 2025. The yen exchange rate is currently hovering around 157.90 (10-month low) hit in November. This level has drawn the attention of policymakers and increased the possibility of intervention.

The Bank of Japan raised interest rates twice last year, but this had little effect on improving the yen's performance, as its prudent pace disappointed investors, and speculators even withdrew a large number of long positions held in the yen in April.

Additionally, investors are increasingly uneasy about the fiscal expansion under Prime Minister Sanae Takaichi, although she has tried to allay some of those concerns.

Traders expect the Bank of Japan's next rate hike to be at the end of 2026. ING senior economist Min Joo Kang predicts the most likely timing is October.

“Further fiscal stimulus may be counterproductive to the economy, but the current administration is expected to maintain its expansionary policy stance, which poses a significant risk to the economy in 2026,” Kang wrote in a client note.

The Australian dollar and the New Zealand dollar are off to a good start to the new year. The Australian dollar rose 0.35% to $0.66975 on Friday after rising nearly 8% in 2025 (the strongest annual performance since 2020).

The New Zealand dollar rose nearly 3% last year, ending three consecutive years of decline. The New Zealand dollar rose slightly to $0.5761 on Friday.