The global foreign exchange market exhibited significant divergence during the week of February 2nd to February 6th, pulled by multiple competing factors. The U.S. dollar index showed strong upward momentum mid-week. Despite a pullback on Friday, it still recorded a considerable weekly gain. This strength was underpinned by a market reassessment of the Federal Reserve's policy path and deep focus on U.S. economic data, particularly concerning the labor market. Concurrently, non-U.S. currencies displayed varied performances: the euro and British pound faced pressure due to dovish stances from their respective central banks, while the Japanese yen suffered a sharp decline ahead of a national election, becoming the weakest-performing major currency for the week. Geopolitical uncertainty, policy signals from major central banks, and upcoming key economic data collectively defined the volatile theme of the forex market.
The U.S. Dollar Index: Economic Data Sways Rate Cut Expectations, Dollar Closes Higher for the Week. This Week's Performance Recap. The U.S. dollar index displayed a volatile but upward trend this week. It strengthened initially, boosted by news related to the nominee for Fed Chair, then faced pressure from weaker-than-expected labor market data, yet overall demonstrated notable resilience. On Friday, as risk appetite improved, the dollar index retreated from a two-week high to close lower for the day. For the entire week, the dollar index accumulated a gain of 0.54%.
Key Data and Events. Federal Reserve Leadership Change: News from the previous week regarding the nomination of former Fed Governor Kevin Warsh as the next Chair continued to influence markets. Historically known for a hawkish stance, Warsh's recent advocacy for rate cuts and his views on reducing the balance sheet were interpreted by markets as potentially leading to tighter financial conditions, initially providing support for the dollar. Mixed Labor Market Signals: U.S. employment data released during the week caused market fluctuations. Thursday's report showed weekly jobless claims rose more than anticipated, and December's job openings fell to their lowest level in over five years. These figures heightened concerns about a cooling labor market, temporarily weighing on the dollar and Treasury yields. Federal Reserve Officials' Comments: Fed Vice Chair Jefferson expressed "cautious optimism" about the economy on Friday, stating the current policy stance is adequate to navigate changes. San Francisco Fed President Daly described the economy as being in a "wobbly" state. The cautious tone from officials shifted market focus squarely onto incoming economic data. Shifting Market Expectations: Federal funds futures indicated traders increased their expectations for Fed rate cuts this year, with the priced-in magnitude of easing larger than earlier in the week. Market attention is now fully turned to the delayed January non-farm payrolls report, postponed due to a government shutdown, scheduled for release next week.
Institutional and Analyst Views. Scott Pike of Income Research + Management noted the market's "intense focus" on labor market developments, suggesting that data showing genuine, sustained weakness could justify further Fed rate cuts. He identified an unexpected non-farm payrolls figure as the "most likely catalyst" to significantly alter the market's view of the Fed's path. Matt Weller of StoneX suggested that if next week's jobs report confirms labor market softness, a Fed rate cut in March is highly probable. He also mentioned that traders are still assessing potential policy shifts under a Warsh-led Fed. Dan Tobon of Citi analyzed from a market correlation perspective, pointing out that Friday's dollar weakness was related to a "reversal of some correlations" driven by a rebound in equity markets.
Euro/U.S. Dollar (EUR/USD): ECB Downplays Exchange Rate Impact, Euro Closes Lower After Fluctuations. This Week's Performance Recap. The euro initially fell against the U.S. dollar this week before recovering. It registered a significant 0.51% drop on Monday, traded in a range through mid-week, and rebounded to close higher on Friday alongside improved market risk sentiment. However, due to the substantial early-week decline, EUR/USD still accumulated a weekly loss of 0.31%, failing to recoup all losses.
Key Data and Events. ECB Interest Rate Decision: On Thursday, the European Central Bank, as widely expected, left interest rates unchanged. Its policy statement downplayed the impact of exchange rate fluctuations on future decisions, a stance interpreted as dovish that failed to provide upward support for the euro. Broad Market Sentiment Driver: The euro's trajectory was largely dictated by the overall strength of the U.S. dollar and shifts in global risk appetite. The euro faced pressure when the dollar strengthened on U.S. data or Fed-related news, but found breathing room when risk-off sentiment eased.
Institutional and Analyst Views. Market analysis widely viewed the ECB's communication as dovish, signaling no urgency to change policy. Against a backdrop of fluctuating Fed rate cut expectations and lackluster Eurozone growth momentum, the euro is seen as struggling to find sustained independent upward momentum in the short term, with its path expected to remain highly inversely correlated to the U.S. dollar index.
British Pound/U.S. Dollar (GBP/USD): BoE Surprises by Holding Rates Steady, Pound Suffers Sharp Decline. This Week's Performance Recap. The British pound experienced turbulent trading against the U.S. dollar this week, showing a distinct "V-shaped" pattern. On Thursday, following the Bank of England's rate decision, the pound plummeted 0.82% in a single day. It then rebounded 0.60% on Friday, driven by short covering and a broader pullback in the dollar. Despite the Friday recovery, GBP/USD still recorded a weekly loss of 0.55%, weighed down by Thursday's deep decline.
Key Data and Events. Bank of England Interest Rate Decision: On Thursday, the BoE unexpectedly decided by a narrow majority to keep rates unchanged. More surprisingly, its policy statement indicated that if recent declines in inflation expectations persist, the Bank could consider reducing borrowing costs. This clear dovish pivot was the direct cause of the pound's sharp drop on Thursday. Policy Divergence Expectations: The BoE's communication led markets to significantly bring forward expectations for the timing of UK rate cuts, creating a contrast with the ongoing debate about the Fed's path. This potential divergence in monetary policy between the BoE and Fed is seen as a near-term weight on the pound.
Institutional and Analyst Views. Market participants widely regarded the BoE's decision as a pivotal turning point. Analysts suggested that despite still-elevated UK inflation, the Bank's focus on falling inflation expectations indicates a potential shift in policy priority from fighting inflation more towards preventing an excessive economic slowdown. This suggests the pound's interest rate advantage may diminish in the period ahead.
U.S. Dollar/Japanese Yen (USD/JPY): Election Clouds Gather, Yen's Plunge Takes Center Stage. This Week's Performance Recap. USD/JPY was undoubtedly the most watched currency pair this week. It rose for five consecutive trading days, achieving a "five-day winning streak," and accumulated a substantial weekly gain of 1.60%.
Key Data and Events. Pre-Election Tension in Japan: The core market focus was the Japanese general election scheduled for Sunday, February 9th. While incumbent Prime Minister Sanae Takaichi was expected to be re-elected, markets worried that a victory could lead to further aggressive fiscal spending plans. Fiscal Concerns and Intervention Risks: Concerns about Japan's fiscal discipline have triggered significant volatility in Japanese Government Bonds and the forex market. Fears persist that an election result interpreted as a mandate for unchecked fiscal spending could exacerbate yen depreciation and bond selling. The yen's sharp weakness has also sparked widespread discussion about potential currency intervention by Japanese authorities.
Institutional and Analyst Views. Matt Weller of StoneX explicitly stated that the key to the election is whether the outcome is perceived as an endorsement for "aggressive fiscal spending." If so, he believes the Nikkei index could continue rising while the yen weakens further. He warned, "The relative weakness of the U.S. dollar in recent weeks has masked more severe weakness in the yen. This trend could accelerate next week and beyond. I believe authorities may ultimately be forced into direct intervention to buy time." Most analysts agree that markets will remain highly cautious on the yen until the election outcome is clear. The recent plunge reflects not just interest rate differentials and dollar strength, but more profoundly, deep-seated concerns about the direction of Japan's fiscal policy and its potential impact on the yen's fundamental credibility.
Week in Review and Outlook. Reviewing the week of February 2nd to 6th, the driving forces in the forex market were clear: battles over monetary policy expectations and political event risks. The U.S. dollar gained the upper hand due to its relative interest rate advantage and resilience to key data; the euro and pound were overshadowed by dovish leans from their central banks; and the yen became the biggest casualty, suffering under high uncertainty surrounding Japan's domestic political and economic policies. Looking ahead to next week, markets face decisive moments: the official outcome of the Japanese election will determine whether the yen's decline continues or finds respite. The delayed U.S. January non-farm payrolls report will serve as a crucial test for U.S. economic momentum, thereby influencing Fed rate cut expectations. Additionally, subsequent speeches from major central bank officials and developments in geopolitical tensions will continue to unsettle market nerves.