The dollar traded mixed on Wednesday as U.S. Treasury yields fell following data showing core consumer inflation slowing, reinforcing expectations that the Federal Reserve may cut rates this year. Treasury 2-year yields dropped to 4.26%, erasing gains from Friday’s strong payrolls report. Federal Reserve officials highlighted continued progress in taming inflation, with Chicago Fed President Austan Goolsbee expressing optimism for a soft landing in 2025. New York Fed President John Williams noted that rising U.S. bond yields do not indicate significant changes in market inflation expectations. However, market uncertainty about President-elect Donald Trump’s policies kept investors cautious. Retail sales and jobless claims reports on Thursday could provide further clarity on the U.S. economic outlook.

Yen Surges on BOJ Rate Hike Speculation Amid Yield Convergence

USD/JPY fell sharply, hitting its lowest level since December’s Fed meeting as U.S.-Japan yield differentials narrowed. Hawkish comments from Bank of Japan Governor Ueda fueled speculation about a potential BOJ rate hike in January, adding pressure to the pair. Dip buyers emerged near 156, supported by a rebound in U.S. equities and stabilized yields. However, one-week option skews remained tilted toward yen calls ahead of Monday’s U.S. presidential inauguration, reflecting ongoing caution.

Euro Struggles Amid Tightening Yield Differentials

EUR/USD erased earlier gains, stalling near its 21-day moving average of 1.0350 as euro crosses faced pressure from tightening German-U.S. spreads and limited dollar selling. European Central Bank Vice President Luis de Guindos reaffirmed plans for further rate cuts if inflation continues to ease but cautioned against risks from trade tensions and rising debt levels, adding to the euro’s vulnerabilities.

Pound Stabilizes on Slowing Inflation and BOE Commentary

Sterling gained modestly after British inflation slowed to an annualized 2.5% in December, easing concerns in the gilt market. Bank of England policymaker Alan Taylor advocated for swift interest rate reductions, citing signs of an economic slowdown. GBP/USD hovered near 1.22 for a third consecutive day, with bearish option skews for sterling beginning to ease.

Commodity Currencies Gain as Oil and Copper Rally

Commodity-linked currencies outperformed their G10 peers, supported by a rally in commodity prices and gains in U.S. equities:

• Oil: Surged nearly 3% after a draw in weekly EIA inventories and continued worries about Russian supply.
• Gold: Rose 0.63% on lower Treasury yields.
• Copper: Advanced 1.22%, benefiting from improved risk sentiment and a weaker dollar.

Equities Rise on Lower Yields and Risk Optimism

The S&P 500 surged 1.8%, led by gains in sectors sensitive to borrowing costs, as lower yields and optimism lifted equity markets. Treasury yields declined by 9-11 basis points across maturities, with the 2s-10s curve steepening by 3 basis points to +38.9bp, reflecting easing inflation concerns and stabilized markets.

Currency Market Summary: Yen Strength Leads G10 Moves

• EUR/USD: Down 0.17%, pressured by tightening yield spreads and mixed eurozone sentiment.
• USD/JPY: Fell 0.90%, reflecting yen strength on BOJ rate hike speculation and safe-haven demand.
• GBP/USD: Edged up 0.08%, buoyed by easing inflation concerns in the U.K.
• AUD/USD: Gained 0.54%, supported by rising commodity prices and improved risk sentiment.
• Cross-Currency Pairs: EUR/JPY and GBP/JPY declined 1.05% and 0.82%, respectively, as yen crosses reflected haven flows amid global economic uncertainties.

Market Outlook: Central Bank Policies and Geopolitics in Focus

• Dollar: Likely to remain sensitive to inflation trends and upcoming economic data, with retail sales and jobless claims offering near-term direction.
• Yen: Poised for further strength if BOJ commentary and market sentiment sustain expectations for a rate hike.
• Euro: Faces continued pressure unless European growth sentiment improves or inflation data exceeds expectations.
• Pound: Stability depends on BOE signals and inflation trends, with modest gains possible if economic data aligns with market expectations.
• Commodity-Linked Currencies: Likely to benefit from rising commodity prices but remain vulnerable to broader risk sentiment shifts and dollar strength.

Conclusion: Inflation and Central Bank Signals Set the Stage for Volatility

The dollar remains under pressure as falling yields and easing inflation weigh on expectations for aggressive Fed policy, while the yen outperforms on BOJ rate hike speculation. The euro and pound face mixed sentiment from regional economic and inflation trends, while commodity-linked currencies gain on higher oil and copper prices. Key economic data and geopolitical developments will continue to shape market sentiment as investors navigate central bank signals and shifting risk dynamics.