New York/London — The U.S. dollar held near a three-month low in thin year-end trading on Tuesday, poised to close out its worst annual performance since 2017 as investors await Federal Reserve minutes that may reveal deep internal divisions over the 2026 policy path. The currency's 9.6% drop in 2025 has been driven by expectations of Fed rate cuts, narrowing interest rate differentials, and persistent concerns over U.S. fiscal health and political uncertainty.

The euro and British pound are set for their strongest yearly gains in eight years, up 13.7% and 8% respectively, underscoring the dollar's broad-based weakness. With traders currently pricing in two additional Fed rate cuts for 2026, analysts at MUFG forecast the dollar index could fall another 5% next year. "The level of the bar for rate cuts next year doesn’t look that different to this year," they noted, anticipating a cautious but continued easing cycle.

Yen's Conundrum: Policy Disappointment vs. Growth Needs

The Japanese yen traded around 156 per dollar, largely flat for the year despite two Bank of Japan rate hikes. Market disappointment with the BOJ's gradual tightening pace has led speculators to hold a net short position on the currency. Analysts now argue the yen's fate is less about monetary policy and more about growth expectations. "What the yen needs—above all else—is stronger GDP growth," said Kit Juckes of Societe Generale, highlighting a critical strategic pivot in the currency's drivers.

Commodity Currencies Cap Strong Year

The Australian dollar hovered just below a 14-month high, on track for an 8% annual gain—its best since 2020. The New Zealand dollar also snapped a four-year losing streak with a 3.7% rise. Their strength reflects both dollar weakness and a relatively resilient global commodity outlook.

As markets enter 2026, the dollar's trajectory will hinge on the Fed's ability to navigate a high-stakes balancing act between inflation control and economic support. The coming Fed minutes will provide the first clues into the central bank's internal competitive ecosystem of views, setting the tone for what could be another volatile year for the world's primary reserve currency and a complex strategic environment for forex traders.