Fed dovish shift conflicts with economic data: When will the dollar bottom out, and how much longer can gold rise?

The market is experiencing a major shift in monetary policy expectations. After the Federal Reserve’s December decision to signal a dovish stance, the US dollar index dropped to a low of 98.313, down more than 9% year-to-date. However, behind this dollar weakness lies deep divergence—markets are betting that the Fed will continue to be accommodative, but resilient economic and employment data are sending conflicting signals.

False Bottom of the Dollar Index: Market Pricing Wins Over Fed Guidance

This week, the Fed’s decision to cut interest rates by 25 basis points to a range of 3.50%-3.75% was in line with expectations, but the details caused some turbulence. Chairman Powell hinted at a pause in rate cuts in January, emphasizing “a total of 175 basis points of cuts, in the neutral rate range,” implying that subsequent actions will be extremely cautious.

But the market did not buy it. The new Fed dot plot shows only one rate cut expected in 2025, a stark contrast to traders pricing in two cuts (about 50 basis points). This expectation gap disrupted the dollar’s safe-haven appeal—investors had anticipated dollar appreciation or stability, but instead saw signals of policy easing, putting pressure on the dollar index.

UBS FX strategist Serebriakov pointed out the key: “The Fed is relatively dovish, but the Reserve Bank of Australia, Bank of Canada, and European Central Bank have shifted hawkish, leading to increased policy divergence, and the dollar’s weakness will persist.” Additionally, the Fed announced a purchase of $40 billion in short-term government bonds to inject liquidity, further weakening the dollar’s appeal as a safe-haven asset.

Asset Rotation Accelerates: Gold and Emerging Markets Take the Spotlight

The dollar’s weakness directly boosted gold and risk assets. Gold has risen 47% this year, breaking through $4,200 per ounce to reach new highs. Data from the World Gold Council shows central banks have purchased over 1,000 tons (led by China and India), and ETF net inflows have surged. For every 1% decline in the dollar, gold valuations gain additional support—investors see it as an inflation hedge.

Emerging markets are the biggest beneficiaries. The MSCI Emerging Markets Index has gained 23% this year, with stocks and currencies in South Korea, South Africa, Brazil, and others rising together. Goldman Sachs research indicates that the falling dollar attracts capital flows into emerging market bonds and equities, with currencies like the Brazilian real leading the gains. US tech stocks have risen over 20% this year, as dollar depreciation boosts export competitiveness and lowers corporate financing costs—JPMorgan analysis shows that for every 1% decline in the dollar, tech earnings can increase by 5 basis points.

But this chain reaction is a double-edged sword. Dollar weakness has driven up commodity prices like oil (up 10% this year), reigniting inflation concerns. If US stocks overheat, high-beta assets’ volatility will inevitably increase, and market liquidity risks will rise.

Dollar Rebound Window: Employment and Inflation Data as a Watershed

In the short term, the dollar remains weak as the main trend, but it is not a one-way decline. A Reuters poll shows 73% of analysts expect the dollar to weaken further by year-end, but this consensus is very fragile.

The key lies in the CPI data released on December 18 and the upcoming employment report. If inflation remains strong or non-farm payrolls grow unexpectedly (as in September when employment increased by 119,000), intra-Fed divisions (already three dissenters opposed to rate cuts at this meeting) could turn hawkish, pushing the dollar index back to the 100 level. Jefferies economist Kumar bluntly stated: “The market is overreacting to labor market signals; a strong employment report could reverse the entire narrative.”

The widening US fiscal deficit and government shutdown risks (ongoing since November) also temporarily support dollar safe-haven demand. These factors, combined, mean that although the dollar is weak in the short term, a rebound mechanism remains in place.

Asset Allocation Advice: Diversify Risks and Avoid Leverage

Analysts emphasize that the market is at a critical point for reassessing monetary policy. The probability of a weaker dollar in the short term is higher, but the long-term trend depends on the depth of economic slowdown and the Fed’s policy adjustments.

Recommendations for investors: 1. Moderately increase allocations in non-US currencies and gold to hedge against dollar depreciation; 2. Be alert to signs of bubbles in high-beta growth stocks and avoid excessive leverage exposure; 3. Closely monitor December economic data to prepare for a potential dollar rebound. Market volatility will continue, but well-prepared investors can turn risks into opportunities.