Dollar Sinks on US Fiscal and Political Risks

The dollar retreated on Tuesday and has continued to be undercut as foreign investors pull capital from the US amid political risks.  The markets remain nervous about Greenland, even though Mr. Trump said last Wednesday that there was a framework agreement for increased US access to Greenland and that he would not invade Greenland by military force. 

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The dollar is also under pressure on US political uncertainty after President Trump on Saturday threatened 100% tariffs on US imports from Canada if Canada signs a trade agreement with China.  Canada is seeking other trade partners amid President Trump’s liberal use of tariffs during this second administration. 

In addition, the dollar is weighed down by speculation that the US might coordinate FX intervention with Japan to boost the yen, which would dovetail with Mr. Trump’s apparent view that a weak dollar is good for the US as a stimulus to US exports.  The yen rose to a 2.75-month high against the dollar on Tuesday as US authorities reportedly contacted market participants last Friday to check dollar/yen prices, a possible precursor to intervention. The dollar added to its losses on Tuesday after the Conference Board US Jan consumer confidence index unexpectedly fell to an 11.5-year low.

The risk of another partial US government shutdown is also weighing on the dollar.  Senate Democrats threatened to block a government funding deal over Department of Homeland Security/ICE funding after the ICE shooting of an ICU nurse in Minnesota on Saturday.  There could be a partial government shutdown when the current stopgap funding measure expires this Friday.  In addition, the dollar is being undercut by risks to the Federal Reserve’s independence, a growing US budget deficit, fiscal profligacy, and widening political polarization.

ADP reported that US private payrolls rose an average of 7,750 per week in the four weeks ending January 3, the smallest number of new jobs in six weeks.

The US Nov S&P composite-20 home price index rose by +1.39% y/y, stronger than expectations of +1.20% y/y.

The Conference Board US Jan consumer confidence index unexpectedly fell -9.7 to an 11.5-year low of 84.5, weaker than expectations of an increase to 91.0.

The US Jan Richmond Fed manufacturing survey rose +1 to -6, slightly weaker than expectations of -5.

The markets are discounting the odds at 3% for a -25 bp rate cut at this week’s FOMC meeting on Tuesday and Wednesday (Jan 27-28).

The dollar continues to see underlying weakness as the FOMC is expected to cut interest rates by about -50 bp in 2026, while the BOJ is expected to raise rates by another +25 bp in 2026, and the ECB is expected to leave rates unchanged in 2026. 

EUR/USD (^EURUSD) rallied to a 4.5-year high on Tuesday and finished up by +0.87%.  Dollar weakness on Tuesday was the main bullish factor for the euro.  Also, Tuesday’s economic news was supportive of the euro after Eurozone Dec new car registrations rose 5.8% y/y, the sixth consecutive month of increases. 

Swaps are pricing in a 0% chance of a +25 bp rate hike by the ECB at the next policy meeting on February 5.

USD/JPY (^USDJPY) fell sharply by -1.02% on Tuesday as the yen climbed to a 2.75-month high against the dollar.  The yen continues to benefit from speculation that US-Japan joint FX intervention may be forthcoming.  US authorities reportedly called major banks last Friday to request dollar/yen quotes, a possible precursor to intervention.  The yen added to its gains Tuesday after Japanese Finance Minister Katayama said officials “will take action” in line with a US-Japanese FX agreement.

Japan Dec machine tool orders were revised upward by +0.3 to 10.9% y/y from the previously reported +10.6% y/y.

Japan Dec PPI services prices rose +2.6% y/y, slightly weaker than expectations of +2.7% y/y and the smallest pace of increase in 1.75 years.

The markets are discounting a 0% chance of a BOJ rate hike at the next meeting on March 19.

February COMEX gold (GCG26) on Tuesday closed up +0.10 (+0.00%), and March COMEX silver (SIH26) closed down -9.569 (-8.25%). 

Gold and silver prices settled mixed on Tuesday, consolidating after their recent parabolic rally.  On Monday, gold and silver prices surged to all-time highs due to dollar weakness and US political uncertainty.  Also, large US deficits and uncertainty regarding government policies are prompting investors to cut holdings of dollar assets and shift into precious metals. Gold prices recovered their losses on Tuesday and settled unchanged after the dollar index sank to a nearly 4-year low.

Precious metals are supported by safe-haven demand amid uncertainty over US tariffs and geopolitical risks in Iran, Ukraine, the Middle East, and Venezuela.  Also, precious metals are supported by concerns that the Fed will pursue an easier monetary policy in 2026 as President Trump intends to appoint a dovish Fed Chair.  In addition, increased liquidity in the financial system is boosting demand for precious metals as a store of value, following the FOMC’s December 10 announcement of a $40 billion-per-month liquidity injection into the US financial system.

Strong central bank demand for gold is supportive of prices, following the recent news that bullion held in China’s PBOC reserves rose by +30,000 ounces to 74.15 million troy ounces in December, the fourteenth consecutive month the PBOC has boosted its gold reserves. Also, the World Gold Council recently reported that global central banks purchased 220 MT of gold in Q3, up +28% from Q2. 

Fund demand for precious metals remains strong, with long holdings in gold ETFs climbing to a 3.5-year high on Monday.  Also, long holdings in silver ETFs rose to a 3.5-year high on December 23.

On the date of publication,

Rich Asplund

did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes.

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