The dollar extended its December decline against major currencies, with traders positioning for a more dovish Federal Reserve policy trajectory in 2026 amid signs of cooling labor markets and moderating inflation. Market participants say the combination of quarter-end rebalancing flows and evaporating liquidity has amplified moves, creating outsized volatility in traditionally stable pairs.
Currency strategists note that positioning data from the final weeks of 2025 show institutional investors have cut long-dollar exposures to their lowest levels since early 2021, reflecting growing conviction that the Fed will cut rates more aggressively than previously priced. The shift accelerated after December's personal consumption expenditures data surprised to the downside, reinforcing views that inflation has returned sustainably toward the 2% target. "The market is essentially front-running a potential Fed pivot in Q1," said a senior G10 currency trader at a major Wall Street bank, requesting anonymity as they aren't authorized to speak publicly. "Every piece of soft economic data gets magnified in this environment."
Euro strength has emerged as a primary beneficiary of dollar weakness, with the single currency gaining ground on both policy divergence expectations and reduced geopolitical risk premiums following recent diplomatic developments. Meanwhile, commodity-linked currencies including the Australian and Canadian dollars have outperformed as crude oil prices stabilized and traders rotated toward growth-sensitive assets heading into the new year. The Japanese yen has also advanced, though gains have been more measured as the Bank of Japan maintains its cautious approach to policy normalization despite domestic inflation exceeding targets for fifteen consecutive months.
Technical analysts observe that momentum indicators across major dollar pairs have reached extreme oversold levels not seen since the Fed's last easing cycle, suggesting the potential for corrective bounces in early 2026. However, the broader structural picture remains bearish for the greenback, with multi-month downtrends intact and key moving averages providing resistance on any rally attempts. Traders are now focused on January's non-farm payrolls report and the Fed's first policy meeting of 2026 as potential catalysts for the next major directional move.
Disclaimer: This analysis is AI-generated for educational purposes. Traders should verify all information and conduct their own research before making trading decisions.