By Rae Wee
SINGAPORE, Dec 24 (Reuters) - The U.S. dollar was headed for its worst annual performance in more than two decades on Wednesday as investors wagered the Federal Reserve would have room to cut rates further next year even as some of its peers looked set to hike.
The greenback stayed on the back foot in Asia trade, with a solid U.S. GDP reading failing to move the dial on the rate outlook, leaving investors pricing in roughly two more Fed cuts in 2026.
"We expect the FOMC to compromise on two
more 25 bp cuts to 3-3.25% but see the risks as tilted lower," said Goldman Sachs Chief U.S. Economist David Mericle, citing slowing inflation as a reason for the forecast.
Against a basket of currencies, the dollar fell to a 2-1/2-month low of 97.767, and was on track to lose 9.9% for the year, which would mark its steepest annual drop since 2003.
The dollar has had a tumultuous year, whipsawed by President Donald Trump's chaotic tariffs that sparked a crisis of confidence in U.S. assets earlier this year, while his growing influence over the Fed has also raised concerns about its independence.
"The USD risk premium widened in December which suggests USD weakness may reflect growing concerns around Fed independence, not just the monetary policy outlook," HSBC analysts said in a currency outlook report.
"With many other G10 central banks on hold, we think Fed liquidity operations and a slight dovish Fed bias leaves the USD outlook tilted to the downside."
In contrast, the euro, which rose to a three-month high of $1.1806, is up just over 14% for the year thus far, putting it on track for its best performance since 2003.
The European Central Bank stood pat on rates last week and revised upwards some of its growth and inflation projections, in a move that likely closes the door to further easing in the near term.
Traders have since responded by pricing in a slim chance of tighter policy next year, mirroring expectations for Australia and New Zealand, where the next moves are seen as being hikes.
That has in turn lifted the two Antipodean currencies, with the Australian dollar, up 8.4% to date, scaling a three-month peak of $0.6710 on Wednesday.
The New Zealand dollar similarly touched a 2-1/2-month high of $0.58475, having risen 4.5% for the year thus far.
Sterling was up at a three-month peak of $1.3531 and has gained more than 8% for the year. Investors are betting the Bank of England will deliver at least one rate cut in the first half of 2026, and place a roughly 50% chance on a second before the year-end.
TRADERS ON YEN INTERVENTION ALERT
For now, the main focus for the foreign exchange market remains on the yen, with traders alert to the possibility of an intervention from Japanese authorities to stem the currency's slide.
Finance Minister Satsuki Katayama said on Tuesday that Japan has a free hand in dealing with excessive yen moves, issuing the strongest warning to date on Tokyo's readiness to intervene.
Her remarks arrested the yen's declines, with the Japanese currency last 0.4% stronger at 155.60 per dollar on Wednesday, having risen more than 0.5% in the previous session.
"Moves that are out of line with any observable fundamentals, and year-end trading conditions are a compelling backdrop for intervention and the risk of action over the holiday season is significant," said Kit Juckes, chief FX strategist at Societe Generale.
While the Bank of Japan delivered a long-anticipated rate hike on Friday, the move had been well telegraphed and comments from Governor Kazuo Ueda disappointed some in the market who had been betting on a more hawkish tone, leaving the yen sliding in the aftermath.
That has left investors vigilant to official yen-buying from Tokyo, particularly as trading volumes thin towards the year-end, which analysts say would make an opportune time for authorities to strike.
(Reporting by Rae Wee; Editing by Jamie Freed)
