Foreign Exchange Commentary

Summary

• The Federal Open Market Committee (FOMC) cut interest rates by 25 basis points, making the benchmark rate 3.75%

• The FOMC made the ruling 9-3 with dissents from Goolsbee, Miran, and Schmid

• U.S labor market continues to cool with initial jobless claims coming in at 236,000 vs 220,000 expected

• The DXY is at 98.49, levels last seen in October as the market prices in additional rate cuts in 2026.

• The Reserve Bank of Australia, Swiss National Bank, and Bank of Canada all kept rates unchanged

• The Bank of Japan is looking to raise rates next week to 0.75%

• The euro is at nine-week highs against the U.S. dollar
  

Big Picture: Global Central Bank Action

The Federal Open Market Committee (FOMC) had their final meeting for 2025 and as expected, cut the benchmark interest rate by 25 basis points on Wednesday. It’s been a turbulent year for the U.S. dollar index (DXY) which compares the U.S dollar to a basket of G10 currencies – the index which was as high as 110 in January is currently at 98.49; levels last seen in October and a reflection of the bearish sentiment that has surrounded the greenback over the last year.

There were three dissents from the FOMC: Chicago Fed President Austan Goolsbee and Kansas City Fed President Jeffrey Schmid both voted for no cuts while Governor Stephen Miran asked for a 50bp cut. The Federal Reserve has faced a complicated battle over the last year; wrestling with a cooling labor market, sticky inflation, and the Trump Administration which has fought for influence within the ranks of the FOMC.

In the most recent meeting, the decision to cut rates appeared more hawkish than dovish, with Fed Chairman Jerome Powell commenting that the U.S. economy is “well positioned to wait and watch” but conceded that a rate hike isn’t “in anyone’s base case.” After US initial Jobless claims data came in at 236,000, higher than the expected 220,000, the market moved towards favoring three 25bp rate cuts for 2026 though it appears the Fed would prefer fewer.

This sentiment may change after the next Federal Reserve chairman is selected. President Trump, in an interview with Politico, stated that he would only pick someone to succeed Powell if they were committed to cutting interest rates immediately. Currently, the shortlist consists of Fed Governors Christopher Waller and Michelle Bowman and favorite Kevin Hassett – the current director of the National Economic Council for the Trump administration.

Current Fed Chairman Powell lists tariffs as the primary reason for the “inflation overshoot” but believes they are only a one-time increase in prices. Regardless, the K-shaped, bifurcated post-pandemic economic recovery continues to be burdensome for small businesses and middle-class Americans, who are facing record levels of credit utilization and an affordability crisis while the more affluent spender appears to be doing well. Currently, the Personal Consumption Expenditure the Fed’s preferred inflation gauge indicates that prices have risen 0.2% month over month and about 2.8% for the year. Inflation has remained over the neutral rate of 2% since March 2021.

The Bank of Canada also held its interest rate decision on Wednesday electing to keep rates unchanged at 2.25%. While the BoC attested that the economy and labor market remain resilient, there remains downside risks associated with “subdued economy-wide hiring intentions.” The Canadian dollar has gained nearly 2% since the start of December against the U.S. dollar.

The Australian dollar has also seen a December rally against the U.S. dollar up nearly 2% as well. In a speech following its decision to leave rates steady at 3.60%, the Reserve Bank of Australia Governor Michele Bullock ruled out rate cuts in 2026 and mentioned the possibility of a hike.

The Australian economy continues to battle high inflation with a 3.8% reading from October, and faces a similar labor issue as the United States: where the unemployment rate isn’t particularly concerning coming in at 4.3% but the issue is on the job creation front - where Australia is reporting the lowest levels in over 10 years (leaving out COVID), and the labor force participation rate continues to drop as well. Currently, money markets are expecting about 40 bps of rate hikes by December 2026.

Though most G10 currencies posted gains against the U.S. dollar this week, the Japanese Yen remains weak as the Bank of Japan determines the next steps on monetary policy. BoJ Governor Kazuo Ueda is working to redefine the neutral rate, which currently sits in a 1-1.25% nominal range. With traders currently expecting a benchmark rate hike to 0.75% on Friday, December 19th there could be even further hikes from the BoJ, who faces sticky inflation concerns. The famous “carry-trade” where investors borrow billions of dollar-yen at cheap near zero rates and invest the funds into higher-yielding assets, could be unwound and force sell-offs. The last time the BoJ raised rates was late July 2024 and the S&P 500 dropped nearly 8% in the subsequent days as traders scrambled to reset their positions.

Back over in Europe, the euro dollar hit a nine-week high, supported by an aligned European Central Bank that doesn’t expect rate cuts anytime soon. Momentum appears to favor the euro with the 20-day moving average trending above the 50,100, and 200-day moving averages, indicating the rally could extend even further. In fact, ECB President Christine Lagarde indicated that she’s intending to raise eurozone growth projections due to the economy’s continued resilience. The ECB will meet next week, though it is largely expected to keep rates steady at 2%.

One of the drags on the euro, France’s political instability, was slightly eased after its national assembly narrowly approved the state’s social-security bill, though Sébastian Lecornu’s minority government still needs to pass the state budget.

Despite the euro gaining against the U.S dollar, it has extended losses for multiple days against the Swiss Franc, currently trading around 0.9326 euros to one franc. The Swiss National Bank opted to keep its interest rates unchanged at 0% on Thursday, citing modest economic growth for the Swiss economy and GDP expectations for the year around 1.5%. SNB Chairman Martin Schlegel said the bank’s monetary stance will remain expansive as Switzerland has seen low inflation and as such, a negative interest rate is a possibility, though unlikely in the short run to stimulate the economy further.