The U.S. dollar started 2026 with a positive bounce on Friday after struggling against most currencies last year, while the yen inched back toward a 10-month low as traders awaited U.S. economic data to predict interest rate moves this year.
A narrowing interest rate difference between the U.S. and other economies cast a shadow over markets last year, resulting in sharp gains against the dollar for most major currencies, except for the Japanese yen.
Worries about the U.S. fiscal deficit, a global trade war, and concerns about Federal Reserve (Fed) independence took a toll on the greenback, and those issues are likely to linger into 2026.
Markets in Japan and China were closed on Friday, making for light trading volume and little movement.
"Market liquidity should improve next week alongside a fuller data slate," said Jens Naervig Pedersen, FX strategist at Danske Bank.
The euro was down 0.2% at $1.1725 on the first trading day of the year, as eurozone manufacturing activity fell in December to its weakest in nine months, a survey showed. The currency surged 13.5% last year, its biggest annual rise since 2017.
Sterling last bought $1.3439 following a 7.7% increase in 2025, also its biggest yearly jump since 2017.
The dollar index, which measures the U.S. currency against six other units, was up 0.2% on Friday at 98.44 after registering a 9.4% decline in 2025, its biggest drop in eight years.
Economic data, including U.S. payrolls and jobless figures, are due next week, providing clues on the health of the labor market and where the Fed's policy rate may end up this year.
Much of the focus at the start of the year will be on whom U.S. President Donald Trump chooses to be the next Fed chair as the term of current head Jerome Powell ends in May.
Trump flagged that he would make his Fed chair pick this month, with White House economic adviser Kevin Hassett the current favourite on betting site Polymarket.
Investors are bracing for Trump's pick to be more dovish and cut rates, as the president has repeatedly criticised Powell and the Fed for not lowering borrowing costs more swiftly or deeply.
Traders are fully pricing in two cuts this year compared to one projected by a currently divided Fed board.
"We expect that concerns around central bank independence will extend into 2026, and see the upcoming change in Fed leadership as one of several reasons why risks around our Fed funds rate forecast skew dovish," Goldman strategists said.
The yen was at 156.90 per U.S. dollar after rising less than 1% against the greenback in 2025. It remained close to a 10-month low of 157.90 touched in November, which drew policymaker attention and raised the prospect of intervention.
The Bank of Japan (BOJ) hiked interest rates twice last year, but that did little to improve yen performance as the cautious pace frustrated investors, with speculators reversing significant long yen positions held in April.
There has also been growing investor unease about fiscal expansion under Prime Minister Sanae Takaichi, though she has sought to ease some of that concern.
Traders are pricing the next BOJ rate hike as being toward the end of 2026. Min Joo Kang, senior economist at ING, expects the most likely timing to be October.
"A further fiscal push could backfire on the economy, but the current government is expected to maintain its expansionary policy stance, posing a significant risk to the economy in 2026," Kang said in a client note.
The Australian and New Zealand dollars started the new year on the front foot. The Aussie was 0.3% higher at $0.6691 after a nearly 8% rise in 2025, its strongest yearly performance since 2020.
The kiwi snapped its three-year losing streak with a nearly 3% gain last year. On Friday, it firmed a touch to $0.5770.
