Dollar Edges Higher on Strength in US Service Sector Activity

The dollar index (DXY00) on Wednesday rose by +0.11%.  The dollar recovered from early losses on Wednesday and moved higher after Dec ISM services index unexpectedly expanded at its fastest pace in 14 months.  The dollar also rose amid increased safe-haven demand after the US seized a Russian-flagged tanker for sanctions violations. 

The dollar initially moved lower on Wednesday on signs of weakness in the US labor market after the Dec ADP employment report showed private employers added fewer jobs than expected, and the Nov JOLTS report showed fewer job openings than expected, both of which are dovish for Fed policy.  Wednesday's slide in T-note yields also weakened the dollar's interest rate differentials. 

The US Dec ADP employment change increased by +41,000, weaker than expectations of +50,000.

The US Dec ISM services index unexpectedly rose +1.8 to 54.4, stronger than expectations of a decline to 52.2 and the strongest pace of expansion in fourteen months.

US Nov JOLTS job openings fell -303,000 to a 14-month low of 7.146 million, showing a weaker labor market than expectations of 7.648 million.

US Oct factory orders fell -1.3% m/m, weaker than expectations of -1.2% m/m.

The markets are discounting the odds at 12% for a -25 bp rate cut at the FOMC's next meeting on January 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. 

The dollar is also under pressure as the Fed boosts liquidity in the financial system, having begun purchasing $40 billion a month in T-bills in mid-December.  The dollar is also being undercut by concerns that President Trump intends to appoint a dovish Fed Chair, which would be bearish for the dollar.  Mr. Trump recently said that he will announce his selection for the new Fed Chair in early 2026.  Bloomberg reported that National Economic Council Director Kevin Hassett is the most likely choice as the next Fed Chair, seen by markets as the most dovish candidate.

EUR/USD (^EURUSD) on Wednesday fell by -0.05%.  The euro came under pressure on Wednesday amid euro-negative economic news: Eurozone Dec core consumer prices rose less than expected, and German Nov retail sales unexpectedly declined by the most in 17 months, both of which are dovish for ECB policy.

Eurozone Dec CPI rose +2.0% y/y, right on expectations.  Dec core CPI rose +2.3% y/y, weaker than expectations of +2.4% y/y.

German Nov retail sales unexpectedly fell -0.6% m/m, weaker than expectations of a +0.2% m/m increase and the biggest decline in 17 months.

Swaps are pricing in a 1% chance of a +25 bp rate hike by the ECB at the next policy meeting on February 5.

USD/JPY (^USDJPY) on Wednesday rose by +0.07%.  The yen gave up an early advance on Wednesday and turned lower amid the escalation of China-Japan tensions, following China's announcement of export controls on items destined for Japan that could have military uses, which could worsen supply chains and negatively affect Japan's economy.  The yen was also pressured after the Japan Dec S&P services PMI was revised downward. Losses in the yen were limited on Wednesday due to a decline in T-note yields, a bullish factor for the yen. 

Japanese fiscal concerns continue to pressure the yen, as Prime Minister Takaichi's government is set to boost defense spending next fiscal year to a record level as part of a 122.3 trillion-yen ($780 billion) budget approved by Japan's cabinet.

The markets are discounting a 0% chance of a BOJ rate hike at the next meeting on January 23.

February COMEX gold (GCG26) on Wednesday closed down -33.60 (-0.75%), and March COMEX silver (SIH26) closed down -3.426 (-4.23%). 

Gold and silver prices fell from 1-week highs on Wednesday and settled sharply lower.  Precious metals retreated on Wednesday as a stronger dollar sparked profit-taking after recent parabolic rallies to all-time highs. There are also near-term concerns that a broad rebalancing of commodity indexes may be undercutting precious metals prices.  Citigroup estimates there could be outflows of $6.8 billion from gold futures contracts and roughly the same from silver due to the reweighting of the BCOM and S&P GCSI indexes, the two largest commodity indexes.  Wednesday's lower global bond yields were supportive of precious metals.

Precious metals have ongoing support amid safe-haven demand amid uncertainty over US tariffs and geopolitical risks in 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 Wednesday's 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 3.25-year high last Tuesday.  Also, long holdings in silver ETFs rose to a 3.5-year high on December 23.