In the first full trading week of January 2026, U.S. markets shrugged off Washington drama and powered higher—apparently unfazed by the Fed's stingier-than-expected rate cut forecast. The S&P 500 advanced 1.6%, the Nasdaq 100 climbed 2.2%, and the Dow Jones hit historic highs. Turns out investors don't always listen when central bankers try to play hardball.
The Federal Reserve cut rates three times in 2025, then declared it expects just one more cut in 2026. Markets looked at that guidance and basically laughed. Traders are pricing in two-and-a-quarter cuts, targeting a 3% Fed funds rate. Someone's going to be wrong here.
Small-caps stole the show. The Russell 2000 surged 4.6%, its strongest start since 2021. That's a big deal. It suggests the rally is finally spreading beyond the mega-cap tech darlings that dominated for years. Market breadth improved markedly, with smaller-cap segments expected to lead in 2026.
The bond market stayed relatively calm. Investment-grade core bonds gained 1.1% in Q4 2025, high-yield added 1.3%, and U.S. core bonds returned a solid 7.3% for the full year. Credit spreads sit near multi-decade tights, which either signals confidence or complacency depending on your mood.
But here's the catch: equity valuations are sitting at 23 times forward earnings. The long-term average? Just 15.6 times. That's a premium investors are betting on continued earnings growth to justify. Real GDP growth projections of 2.0-3.0% provide some cover, but not much room for error.
A government shutdown delayed key economic reports in late 2025—retail sales, industrial production, housing starts, all pushed back. Federal workers are still catching up. The shutdown shift sentiment negatively, though apparently not enough to derail the January rally. Traders closely monitored the Economic Calendar for rescheduled releases of these critical indicators that typically drive currency and equity positioning.
Health Care led sectors in Q4 with an 11.22% gain, while Utilities and Real Estate lagged badly. Technology managed just 2.14%, roughly matching the index. And there's this: the first five trading days of January finished positive, which historically gives an 83% probability of a positive year ahead. Superstition? Maybe. But markets love their patterns.
Meanwhile, the BIS Triennial FX Survey continues to provide critical insights into global foreign exchange market structure and trading volumes, helping analysts understand cross-border capital flows that influence dollar movements during periods of policy uncertainty. The dollar's reaction to Fed policy divergence highlighted how order flow dynamics and liquidity provision mechanisms in forex markets can amplify volatility when institutional participants reassess their positioning.
