Guotai Haitong Securities noted that the recent partial U.S. government shutdown delayed the release of inflation data by several days, which ultimately weighed on the U.S. dollar. Before that, strong U.S. non-farm payrolls had temporarily supported dollar strength. Overall, the dollar is experiencing short-term volatility due to conflicting signals from employment and inflation figures. However, medium-term downward pressure on the dollar is expected from three factors: declining inflation, geopolitical risks, and an anticipated shift in Federal Reserve policy. Among non-U.S. currencies, the euro holds relative advantages, while the British pound faces political uncertainty and may experience near-term fluctuations. Additionally, gold, serving as a hedge against both policy uncertainty and geopolitical risks, is expected to maintain upward support.

The strong U.S. employment report was released first. January non-farm payrolls significantly exceeded expectations, adding 130,000 jobs compared to market forecasts of 65,000. Private sector employment showed clear improvement, with education and healthcare as the main contributors. Notably, employment in most private industries has continued to recover since October 2025, indicating ongoing labor market resilience. At the same time, the labor force participation rate rose, while the unemployment rate unexpectedly fell to 4.3%, below expectations, suggesting that more people are returning to work and job supply remains sufficient. Wage growth also improved, with average hourly earnings and weekly working hours both increasing in January, easing near-term concerns about labor market weakness.

The strong data initially dampened expectations for interest rate cuts. According to the CME FedWatch Tool, the probability of a March rate cut dropped sharply to less than 6%, leading to a strengthening U.S. dollar index. However, just days later, the January CPI data delivered a contrasting message, causing the dollar index to turn lower. Overall CPI rose 2.4% year-on-year, the lowest since May 2025, and increased only 0.2% month-on-month, both below expectations. Core CPI increased 2.5% year-on-year, the lowest since March 2021, and although it rose 0.3% month-on-month in line with expectations, it was significantly dragged down by a 1.8% drop in used car prices. Energy prices also continued to decline, with gasoline prices falling 3.2% month-on-month and 7.5% year-on-year.

The broad-based cooling of inflation quickly shifted market sentiment, with traders renewing bets that the Federal Reserve would ease policy sooner. The U.S. dollar index fell nearly 20 points in short order, while non-U.S. currencies broadly rebounded. Precious metals surged, driven by both safe-haven demand and expectations of lower real interest rates, with spot gold briefly breaking above $5,033 per ounce.

The dollar's recent movement reflects a tug-of-war between strong employment and weak inflation. On one hand, labor market resilience limits the Fed's room for premature rate cuts, supporting the dollar. On the other hand, inflation has substantially declined toward the target level, with a clear downtrend, providing justification for a policy shift. Markets currently view the latter as more influential. Historical patterns suggest that when core inflation remains below 2.5% with no signs of rebound, the Fed tends to prioritize growth and financial stability risks, making rate cuts more likely.

Adding to this, recent escalations in geopolitical tensions—such as the Trump administration's decision to deploy a second aircraft carrier strike group to the Middle East to pressure Iran—have boosted safe-haven demand, further supporting gold and weighing on the dollar. Therefore, although non-farm payrolls provided short-term support for the dollar, medium-term exchange rate direction is likely to be driven by expectations of monetary easing.

The euro benefits from both dollar weakness and improving fundamentals. The European Central Bank kept its three key interest rates unchanged at its February meeting, as expected, but the statement conveyed positive signals: continued expansion in services, increased AI-related investment, and a stable labor market. Against a backdrop of narrowing monetary policy divergence between the U.S. and Europe, the euro enjoys structural support. January eurozone economic data also showed moderate improvement, reinforcing the euro's position as Fed pivot expectations grow.

In contrast, the British pound has lagged. Although dollar weakness should generally benefit non-U.S. currencies, domestic political risks in the U.K. have significantly limited the pound's rebound. Prime Minister Starmer faces a political crisis following former U.S. Ambassador Mandelson's involvement in the Epstein scandal, leading to several staff resignations and calls for his resignation from the Scottish Labour leader. Although Starmer is not directly implicated, his approval ratings have plummeted, and betting markets suggest he may step down before the end of June. While market volatility has not reached the levels seen during the 2022 "Truss moment," political uncertainty is expected to persist, especially ahead of local elections in May. Concerns that a successor could adopt more left-leaning and fiscally aggressive policies have pushed U.K. bond yields higher and weakened confidence in the pound.

In summary, the U.S. dollar is experiencing short-term volatility due to conflicting employment and inflation data. Strong job numbers indicate economic resilience, making it difficult for the Fed to pivot quickly, which supports the dollar. At the same time, inflation has eased significantly, nearing the target range and showing a sustained downtrend, opening the door for rate cuts and reducing dollar support. Medium-term, however, three factors—falling inflation, geopolitical risks, and a Fed policy shift—are expected to exert downward pressure on the dollar. Among non-U.S. currencies, the euro holds relative advantages, while the pound remains vulnerable to political risks and may face near-term fluctuations. Gold, as a dual hedge against policy and geopolitical uncertainty, is likely to maintain upward momentum, especially in a macro environment where U.S. real interest rates have peaked and begun to decline.