Dollar Stumbles at Start of 2026 as Rate Outlook and Policy Uncertainty Weigh, Yen Lags Peers

BY COMFORT OGBONNA

The U.S. dollar began 2026 on a weak footing on Friday, extending a difficult run from last year when it lost ground against most major currencies, as investors assessed shifting interest rate expectations and ongoing policy uncertainty in the world’s largest economy. Meanwhile, the Japanese yen steadied near a 10-month low, remaining an outlier among major currencies as traders waited for key economic data to guide expectations on how central banks will steer interest rates in the year ahead.

A narrowing gap between U.S. interest rates and those in other major economies weighed heavily on the dollar throughout 2025, allowing most currencies to post strong gains against the greenback. The yen was a notable exception, struggling to attract sustained support despite policy tightening by the Bank of Japan. Persistent concerns about the U.S. fiscal deficit, the risk of an escalating global trade war, and unease over the independence of the Federal Reserve also undermined confidence in the dollar, with many of these issues expected to carry over into 2026.

On the first trading day of the new year, the euro held steady at $1.1752 after surging 13.5% in 2025, while sterling traded at $1.3473 following a 7.7% rise last year. Both currencies recorded their strongest annual gains since 2017, reflecting growing optimism about economic prospects outside the United States and a reassessment of U.S. monetary dominance. Trading volumes were light, however, with markets in Japan and China closed for holidays, limiting price moves.

The dollar index, which tracks the U.S. currency against six major peers, stood at 98.186 after falling 9.4% in 2025, its steepest annual decline in eight years. Some analysts argue the dollar’s era of dominance may have peaked, though opinions remain divided on how far the pullback will go. While the dollar index has not posted back-to-back annual declines in two decades, the relative strength of the U.S. economy could still offer support and fuel a rebound later in the year.

Attention is now turning to a slate of upcoming U.S. economic data, including payrolls and jobless figures due next week, which are expected to provide fresh insight into the health of the labor market and the likely path of Federal Reserve policy. Early in the year, investors are also closely watching who President Donald Trump will nominate as the next Fed chair when Jerome Powell’s term ends in May. Markets are bracing for a more dovish appointee, particularly after Trump repeatedly criticized the Fed for not cutting rates faster or more aggressively. Traders are currently pricing in two rate cuts in 2026, compared with just one projected by the Fed’s divided policy board, reflecting expectations that political pressure and leadership changes could tilt policy toward easier conditions.

Against this backdrop, the yen continued to underperform. It traded at around 156.85 per dollar, having gained less than 1% against the greenback in 2025. The currency remained close to a 10-month low of 157.90 reached in November, a level that previously drew the attention of Japanese policymakers and raised the risk of market intervention. Despite the Bank of Japan raising interest rates twice last year, the cautious pace of tightening failed to lift the yen meaningfully, frustrating investors and prompting speculators to unwind large bullish positions built earlier in the year.

Investor concerns have also been fueled by worries over fiscal expansion under Prime Minister Sanae Takaichi, although she has attempted to reassure markets. Expectations for further BOJ tightening remain subdued, with traders pricing the next rate hike toward the end of 2026. Some economists see October as the most likely timing, warning that additional fiscal stimulus could backfire on the economy if not carefully managed, even as the government maintains an expansionary stance.

In contrast, commodity-linked currencies showed more resilience at the start of the year. The Australian dollar rose 0.35% to $0.66975 after climbing nearly 8% in 2025, marking its strongest annual performance since 2020. The New Zealand dollar also started 2026 on firmer ground, edging up to $0.5761 after snapping a three-year losing streak with a gain of almost 3% last year. Together, these moves underscored a broader shift in currency markets, where the dollar’s dominance is increasingly being questioned as investors reassess growth, policy, and risk across the global economy.