Is it inevitable for central bank policies to shift in 2026?

For the foreign exchange and precious metals markets, 2025 presents a stark contrast. The former is moving extremely slowly, with the implied volatility of foreign exchange options steadily declining according to the Chicago Mercantile Exchange's Volatility Index (CVOL) (Figure 1). However, the option prices for gold, silver, and platinum have surged sharply, as reflected in the CVOL indicators for precious metals (Figure 2). Figure 1: Continuous decline of foreign exchange CVOL throughout 2025 Source: QuikStrike (GBVL, JPVL, EUVL, ADVL, CDVL) Figure 2: Sharp rise in implied volatility of precious metals in 2025 Source: QuikStrike (GCVL, SIVL, POVL) Against the backdrop of relatively stagnant foreign exchange spot rates, the implied volatility in the foreign exchange market has decreased. The Bloomberg Dollar Index has declined throughout 2025, but its fluctuations are relatively small by historical standards (Figure 3). In contrast, precious metal prices have surged sharply: gold and silver have each reached historical highs, while the prices of platinum and palladium have risen nearly 90% from April to October 2025 (Figure 4). So, what are the macroeconomic driving factors pushing precious metal prices higher in a context where exchange rates are nearly flat? If central banks change their policies in 2026 and begin to raise interest rates, what changes will occur in precious metals and currency exchange rates? Figure 3: The fluctuations of the dollar in 2025 are not large by historical standards Source: Bloomberg Professional Services (BBDXY, DXY, as of December 31, 2004) Figure 4: Precious metal prices surge sharply against the dollar and all other fiat currencies Source: Bloomberg Professional Services (GC1, PA1, PL1, SI1) The foreign exchange market is so calm in 2025 partly because the macroeconomic, monetary, and fiscal fundamentals of various countries are highly similar, making it difficult to distinguish and create gaps between different fiat currencies. Simply put, the following statement holds true in most countries and regions: Core inflation rate is above the target level. Despite the core inflation rate being above the target level, almost all central banks are cutting interest rates. Unemployment rates are rising in most countries and regions, and economic growth is weak. Fiscal dominance: Many countries are maintaining large fiscal deficits with no plans to reduce them. While this makes it difficult for various fiat currencies to distinguish themselves, it prompts investors to start looking for assets that cannot be printed by central banks. Observing the largest 21 economies with floating exchange rates that are currently not at war or experiencing hyperinflation, it is found that their inflation rates are on average about 1% higher than the central bank's target level. There are exceptions like China and Switzerland, but the inflation rates of other economies are all above the target level. Inflation rates are not only above the target level but are also continuing to rise in most cases: in these 21 currency zones, the core inflation rate has averaged an increase of 0.2% year-on-year over the past six months. Among them, 12 currency zones recorded an increase in core inflation, 4 recorded a decrease, and 5 remained unchanged (more charts can be found in Figure 5 and the appendix). Figure 5: Core inflation rates are above target levels in almost all countries and regions, and are often on the rise. Source: Bloomberg Professional Services (Core Inflation Rate) The reasons for inflation rates being almost universally above target levels vary by region. In the United States, the United Kingdom, and the Eurozone, the service sector is the main driver of inflation. In other countries like those in Latin America, the main driver is the rise in commodity prices. The deeper roots are related to the large-scale monetary and fiscal stimulus policies implemented in most parts of the world. Many countries spent 10-20% of GDP on COVID-19 related relief. Additionally, many central banks significantly lowered interest rates in 2020 and only began tightening policies in 2022. They then further tightened policies significantly and continued this into 2023. The only exception is China, which spent 3% of GDP on COVID-19 relief, did not experience post-pandemic inflation, and has not tightened policies since 2017. Finally, the rise of protectionism, nearshoring and localization of supply chains, increased military spending, and demographic factors may be pushing inflationary pressures higher. However, it is strange that despite almost all countries and regions having inflation rates above target levels, central banks are currently almost universally adopting accommodative policies. Only two central banks raised interest rates in 2025: the Bank of Japan and the Central Bank of Brazil. Other central banks have all adopted interest rate cuts (Figures 6, 7, 8, 9). Figure 6: Except for the Bank of Japan, the largest central banks in the world are all cutting interest rates. Data Source: Bloomberg Professional Services (FDTRMID, CBAROVER, UKBRBASE, EURR002W, BOJDPBAL, RBATCTR, PBOC7P, SWRATEI, KORP7DR, NZOCR) Figure 7: Central banks in other Latin American countries have implemented easing policies, except for Brazil Data Source: Bloomberg Professional Services (BZSTSETA, CHOVCHOV, CORRRMIN, MXONBR, FDTRMID) Figure 8: Central banks in Eastern European countries have also implemented easing policies Data Source: Bloomberg Professional Services (CZARANN, HBRRANN, POREANN, ROKEPOLA) Figure 9: The Reserve Bank of India has still implemented interest rate cuts despite rising inflation rates Data Source: Bloomberg Professional Services (INBGCEY, INRPYLDP) Major questions for economists and investors to explore include: Will global monetary policy easing lead to faster economic growth? If economic growth does indeed recover, will core inflation rates rise further? Must central banks reverse course and tighten policies in 2026? If so, how will the eventual tightening of policies affect the foreign exchange and precious metals markets? Some may argue that implementing an easing monetary policy while inflation remains above target could trigger a subsequent wave of inflation. This scenario seems to be reflected in the pricing of the precious metals market. Counterarguments suggest that precious metals investors may be overestimating the risks of rising inflation, as central bank easing policies are being implemented against a backdrop of declining inflation rates from 2023 to 2024, and real interest rates remain at relatively high levels (Figure 10). From this perspective, central banks may still be tightening policies, albeit with less intensity than 12 or 24 months ago. Figure 10: The decline in real interest rates is less than that of nominal interest rates Data Source: Bloomberg Professional Services (FDTRMID, CBAROVER, UKBRBASE, EURR002W, BOJDPBAL, RBATCTR, PBOC7P, SWRATEI, KORP7DR, NZOCR, CPI XYOY, CACPTYOY, UKHCA9IC, CPIEXEMUY, JPCNEFEY, ACPMXVLY, (CNCPCRY, CPEXSEYY, SKCIYOY, NZCPIYO) As for investor expectations, further easing of U.S. policy has been reflected in the U.S. short-term interest rate futures market, with traders in SOFR and federal funds futures expecting the federal funds rate to remain around 3% by the end of next year. Similarly, investors in U.K. short-term interest rates (STIRS) also believe that the Bank of England may further ease policy. Traders also believe that the likelihood of further easing in Canada and the Eurozone is low until early 2026, with a possibility of tightening later in 2026 or in 2027. Meanwhile, traders see a possibility of interest rate hikes in Australia and Japan. Japan is an exception in this regard, as the Bank of Japan's policy rate remains well below the core inflation rate (Figure 11). Figure 11: Investors expect the Federal Reserve to further cut interest rates while the Reserve Bank of Australia and the Bank of Japan will raise interest rates Source: Bloomberg Professional Services (KTR1～KTR9, SFR1～SFR9, SFI1～FI9, IR1～IR9, SSY1～SSY9, COR1～COR9, YPO1～YPO9) If there is a divergence in monetary policy among different currencies, with some central banks tightening policy while others continue to ease, this could lead to significant trends in exchange rates and higher volatility. Generally, currencies from central banks that tighten policy tend to appreciate compared to those from central banks that continue to ease. That said, interest rate changes are just one of many macro factors affecting exchange rates, with other factors including relative changes in budget deficits and current account deficits, as well as relative changes in economic growth rates. In general, investors prefer to see budget deficits and current account deficits narrowing (or surpluses expanding), while favoring currencies with accelerating economic growth rather than those with slowing growth. For precious metals, a scenario where U.S. rates decline while rates in other regions remain stable or rise may not be a bad thing, as precious metals are priced in U.S. dollars and thus have a higher sensitivity to the dollar than to other currencies. That said, if the Federal Reserve unexpectedly raises rates in 2026, it could have a significant impact on precious metals, as they typically respond negatively to rising interest rate expectations. One might wonder why central banks are still pursuing accommodative monetary policies given that inflation is above target and still rising in most parts of the world. The answer lies in slowing economic growth, particularly the weak state of the labor market. In many countries, hiring activity has stalled, and unemployment rates are slowly rising. Unemployment rates are trending upward in Australia, Canada, New Zealand, Switzerland, and the United States, as well as in Eastern European countries. In the Eurozone, Japan, South Korea, and much of Latin America, unemployment rates remain stable; Brazil's unemployment rate has decreased, which may explain why the Brazilian central bank is going against the trend and choosing to raise rates (Figures 12-14). The good news is that large-scale layoffs that typically occur during economic recessions have not materialized. However, central banks seem more inclined to maintain economic growth rather than suppress inflation Figure 12: Unemployment rates in many developed economies are on the rise Source: Bloomberg Professional Services (USURTOT, CANLXEMR, UKUEILOR, UMRTEMU, JNUE, AULFUNEM, SZUEUEA, SWUESANE, KOEAUER, NZLFUNER) Figure 13: Unemployment rates in Eastern Europe are also on the rise Source: Bloomberg Professional Services (BRLFUNRT, CHUETOTL, COUNTONT, MXUEUNSA) Figure 14: Unemployment rates in Latin America are stable, with Brazil's unemployment rate declining Source: Bloomberg Professional Services (BRLFUNRT, CHUETOTL, COUNTONT, MXUEUNSA) The U.S. labor market highlights the central bank's complex dilemma. While job growth has clearly slowed, wages in the U.S. continue to grow rapidly at a reasonable pace. This means that total compensation for the workforce continues to grow at around 5% per year, slightly higher than the 4-5% rate that was common in the 2010s (Figure 15). Figure 15: U.S. hiring activity slows, but wage growth remains strong Source: Bloomberg Professional Services (AWH TOTL, AHE YOY%, NDP T), CME Group Economic Research Calculation Team Despite the U.S. unemployment rate being only 4.4% as of September, and the proportion of tariff revenue to GDP rising from 0.2% to 1.1% this year, the U.S. budget deficit remains at a level of 6% of GDP, which is unusually large for the current economic cycle stage. The U.S. is not alone in this. The UK's budget deficit currently stands at 4.5% of GDP. France's ratio is 5.5%. With the new government increasing defense and infrastructure spending, Germany's deficit is expected to expand by 2026. Japan faces a similar situation: despite the public debt-to-GDP ratio nearing 200%, the new prime minister is still calling for increased fiscal stimulus. Many middle-income countries are facing the same situation. Brazil and China's budget deficits account for 8.5% of GDP. Since 2017, China's tax revenue as a percentage of GDP has decreased from 29% to 21% Mexico's budget deficit accounts for 4% of GDP, significantly higher than historical levels, and the unemployment rate has reached a record low. More critically, almost none of these countries are taking decisive action to control the deficit. The global trend has shifted from a central bank-dominated situation over the past few decades (where fiscal policy is either constrained by monetary policy or takes a secondary role) to a fiscal-dominated one. In a fiscal-dominated context, central governments often maintain large deficits, while central banks can only choose to what extent they control inflation or lean towards maintaining economic growth. Due to many countries facing similar (or analogous) situations, investors find it difficult to distinguish between the fiat currencies issued by various governments. As a result, exchange rate fluctuations have weakened. However, if monetary policy, fiscal policy, and economic growth begin to diverge starting in 2026, this situation may change. In contrast, during 2025, many investors believe that, overall, the value of fiat currencies is declining relative to precious metals. If the budget deficit further expands and central banks continue to implement loose policies despite inflation being above target, this trend may persist into 2026. That said, investors holding long positions in precious metals face a significant risk that more central banks may follow the example of the Brazilian central bank and choose to raise interest rates when inflation is slightly above expected levels. So far this decade, the Brazilian central bank has been a leading indicator for other central banks: it raised rates earlier than other Latin American central banks and the Federal Reserve in 2021, and cut rates earlier than other central banks in 2023. If other central banks again follow Brazil's approach, it could curb the upward momentum of precious metal prices, similar to how the rate hike cycle from 2022 to 2023 led to a correction and consolidation in precious metal prices. Figure 16: Inflation rates in all countries and regions globally, except China, are above target levels Source: Bloomberg Professional Services (CPI XYOY, CACPTYOY, UKHCA9IC, CPIEXEMUY, JPCNEFEY, ACPMXVLY, CNCPCRY, CPEXSEYY, SKCIYOY, NZCPIYOY) Figure 17: Inflation rates across Latin America are above target levels, but only Brazil is raising rates Source: Bloomberg Professional Services (BCOITYOY, CNPISAYO, COCPXFYO, MXCCYOY) Figure 18: Core inflation rates in the largest economies of Eastern Europe are above target levels Source: Bloomberg Professional Services (CZARANN, HBRRANN, POREANN, ROKEPOLA)