US MACROECONOMICS: The USD fundamentals are moderately weakening from a moderately weak position
The USD Fundamentals are moderately weakening from a neutral position
A Deepening Weakness
The US dollar continues to face significant headwinds as we move deeper into 2025, with multiple factors converging to pressure the greenback. Throughout the upcoming six months, all macroeconomic factors analysed point to a moderately weakening influence on the fundamental value of the dollar. This outlook stems from Trump's aggressive tariff policies, slowing economic growth prospects, and diminishing safe-haven appeal, creating a challenging environment for the currency despite America's economic strengths.
The dollar has undergone a notable transition over the previous six months, shifting from a moderately strong to a moderately weak position. While projections from late 2024 had anticipated dollar strength in 2025 due to American economic outperformance, this narrative has been upended by recent policy developments that have transformed what was expected to be a period of dollar dominance into one of unexpected vulnerability.
GOVERNMENT & FISCAL POLICY: The Self-Defeating Approach
The Trump administration's aggressive tariff policies will likely weaken the dollar over the next six weeks. Contrary to the governments theory, investors are reacting negatively to the tariffs due to concerns about economic growth.
America's Second Trump Era
The US is a federal republic with 3 branches: executive, legislative, and judicial. President Donald Trump is in his second term, implementing Project 2025's right-wing agenda, focused on tax cuts, deregulation, and restrictive immigration policies.
Mounting Deficits Despite Strong Economy
The US has faced significant fiscal policy challenges in recent months, with the debt limit suspension expiring at the start of 2025 and a new limit of $36.1 trillion becoming binding between January-February. The federal deficit increased to 6.2% of GDP in fiscal 2024, reflecting the ongoing fiscal expansion despite the economy operating near full employment, while the Trump administration has focused on extending the Tax Cuts and Jobs Act (TCJA) and implementing additional tax cuts alongside sweeping new tariffs.
Tax Cuts and Debt Ceiling Drama Ahead
Based on current signals from Washington, market participants expect that a plan proposed by Senate Republicans will likely prevail regarding fiscal policy, splitting off the TCJA extension and other tax cuts into a separate bill to be passed later in 2025. Analysts project about $200 billion worth of personal and business tax cuts per year starting in 2026, while the debt limit will almost certainly be increased or suspended before the "x-date" when cash balances and extraordinary measures are exhausted, likely falling in the summer, perhaps as late as July or August.
ECONOMIC ACTIVITY & GROWTH: Economic Winds Shift Against the Dollar
Concerns about US growth and new tariffs have increased the risk of recession, with some analysts predicting a 0.1% contraction by year-end. This will likely weaken the dollar over the next few weeks and months.
America's Economic Engine
The US has the world's largest economy, with key sectors including technology, healthcare, finance, energy, and manufacturing. Major trading partners include Canada, Mexico, China, Japan, and the EU. Leading companies are Apple, Microsoft, Google, Amazon, and JPMorgan Chase.
Robust Growth Now Threatened
The US economy demonstrated strong performance through the latter half of 2024, with real GDP expanding at 2.8% for the calendar year. This momentum continued into early 2025, with the economy growing at an annual rate of 2.5% in the first quarter, exceeding earlier projections of 1.9%, supported by consumer spending, inventory rebuilding, and business investment alongside a resilient labor market with unemployment falling to 4.1% in March.
Forecasts Diverge on Tariff Impact
Economic projections for the coming months show considerable divergence, highlighting uncertainty surrounding Trump's policies, with forecasts for 2025 economic growth ranging from 1.5% to 2.7%. While the Federal Reserve Bank of Philadelphia's Survey of Professional Forecasters shows increased optimism, with expectations for real GDP to increase 2.4%, more cautious projections from S&P Global Ratings suggest growth will cool to 1.9%, and some brokerages have even raised concerns about a potential recession by year-end following Trump's sweeping new tariffs.
Key Economic Indicators
Unemployment Rate: 4.1% in March 2025, down from 4.2% earlier in the year, expected to rise to 4.3% by year-end
Non-Farm Payrolls: 151,000 jobs added in March, with forecasts of around 145,000 monthly additions through 2025
Inflation (PCE): 2.5% year-over-year in February 2025, showing gradual moderation
Core PCE: 2.8% year-over-year in February 2025, remaining above the Fed's 2% target
Average Hourly Earnings: 4% year-over-year in March 2025
ISM Manufacturing Index: 49.5% in March 2025, indicating contraction
ISM Services Index: 53.0% in March 2025, showing continued expansion
Job Openings: 7.7 million in February 2025
Personal Income: Rose 0.8% in February 2025, exceeding forecasts
Personal Spending: Increased 0.4% in February 2025, slightly below expectations
MONETARY POLICY & INFLATION: Rate Cuts vs. Tariff-Driven Inflation
The dollar may weaken due to speculation that the Federal Reserve will cut rates three more times this year to counter the growth implications of tariffs.
America's Monetary Authority
The Federal Reserve System, the US central bank, comprises a Board of Governors and 12 regional banks. Jerome Powell, initially nominated by President Trump and later by President Biden, leads the Board and operates under a Congressional mandate of maximum employment and price stability.
Easing Cycle Pauses as Inflation Persists
The Federal Open Market Committee initiated a monetary easing cycle in the latter half of 2024, cutting the federal funds rate by 50 basis points in September followed by 25 basis point reductions in both November and December, bringing the target rate range to 4.25-4.50%. In January 2025, the FOMC paused its rate-cutting cycle as inflation remained persistent above the 2% target, while long-term nominal Treasury yields increased markedly, with the 10-year Treasury yield rising from just above 3.6% in mid-September to 4.6% by early February 2025.
Limited Rate Cuts on the Horizon
Financial market prices now imply that the federal funds rate will decline a further 40 basis points from current levels to approximately 3.9% by year-end 2025. Most analysts project only one or two additional 25 basis point cuts this year, with S&P Global Ratings expecting just one cut and the University of Michigan forecasting two cuts in June and December, while the potential for tariff-induced inflation appears to be a key factor limiting the Fed's ability to cut rates more aggressively.
The World's Reserve Currency
The US dollar is the world's primary reserve currency and the most widely used currency in international transactions. Established as the official currency of the United States in 1792, it has since become the global standard for trade, finance, and international reserves, providing the US with significant economic advantages, including lower borrowing costs, the ability to finance trade deficits, and substantial geopolitical leverage.
Stubborn Price Pressures
Inflation has gradually moderated over the past six months but remains above the Federal Reserve's 2% target, with PCE rising 2.5% year-over-year in February 2025, down slightly from 2.6% in December 2024. Core PCE inflation stood at 2.8% year-over-year in February, having shown only limited progress toward the 2% target, while wage growth has contributed to these pressures with average hourly earnings rising 4% year-over-year in March 2025, making it more challenging for inflation to return to the Fed's target.
Tariffs Set to Push Prices Higher
Inflation projections for the coming months have been revised upward due to the expected impact of Trump's new tariff policies. S&P Global Ratings forecasts that inflation will remain closer to 3.0% in 2025 as tariffs increase prices along domestic supply chains and for end consumers, while the University of Michigan projects that annualized core PCE inflation will moderate to 2.2% by the fourth quarter of 2025, though most economists agree the new tariffs will create upward pressure on prices, potentially delaying the return of inflation to the Fed's 2% target.
GEOPOLITICS, CAPITAL FLOWS & RISK: Upheaval and Capital Flight
The dollar is weakening due to geopolitics, capital flows and risk factors. Investors are shunning the dollar during market turbulence, and analysts warn of major shifts in capital flow allocations and disorderly FX moves.
Trump's Unilateral Foreign Policy Disrupts
The Trump administration has undertaken a decidedly unilateralist, transactional, and confrontational foreign policy approach. Relations with China are deteriorating rapidly, with tariff rates on Chinese imports increased by 20 percentage points to just above 30%, while China has announced retaliatory measures. Russia continues to pose significant challenges to the international order, with the ongoing war in Ukraine entering a new phase following US policy shifts, and the Middle East remains volatile with ongoing conflicts threatening regional stability.
America's Capital Magnetism
The United States typically attracts substantial foreign capital due to the size and liquidity of its markets, the safety of US Treasury securities, and the dollar's status as the world's reserve currency. Capital flows into the US take various forms, including foreign direct investment, portfolio investment in stocks and bonds, and cross-border lending, helping finance the US government's budget deficit and current account deficit, with the composition historically featuring strong portfolio inflows into US debt and equity markets.
From Inflows to Outflows
Capital flows to the United States have shown significant volatility over the past six months, with the US recording an all-time high capital inflow of $398,900 million in September 2024, followed by strong but moderating inflows through December. However, January 2025 saw a reversal with a net TIC outflow of $48.8 billion, while Treasury yields surged before the November 2024 elections, eased in mid-November, but climbed again with the 10-year yield reaching a 14-month high of 4.6% by early February 2025.
Capital Caution Amid Policy Uncertainty
Analysts project more cautious capital flows to the United States in the coming months as markets assess the impact of new tariffs and potential retaliatory measures. The initial market enthusiasm following Trump's election has given way to more nuanced concerns about inflation and growth implications of protectionist policies, with the higher tariff regime expected to impact capital allocation decisions and market participants closely watching the Treasury market for signs of reduced foreign appetite for US government debt.
Volatility Spikes on Recession Fears
Market risk has increased significantly in recent months due to several factors, with brokerages raising alerts about the "high risk" of the US economy falling into recession following Trump's sweeping new tariffs. The beginning of Trump's second term has introduced several policy uncertainties, including looser regulations, mass deportations, tariffs, and potential tax cuts, creating unpredictability that markets struggle to price efficiently, with the S&P 500 showing increased volatility as specific policy details have emerged.
Balancing Growth Hopes Against Policy Fears
Market expectations for the coming months reflect a balancing act between optimism about growth-friendly tax policies and concerns about inflation and trade tensions. Analysts anticipate continued elevated volatility as markets digest the implications of tariffs, with particular attention to inflation readings that will influence Federal Reserve policy decisions, while the potential for geopolitical escalation remains a significant risk factor with US relations with China, Russia, and European allies all showing signs of strain.
CONCLUSION: Approaching Turbulence
The dollar is set to face continued pressure in the weeks ahead. While tariffs should theoretically strengthen a currency, markets are instead focusing on their negative growth implications, creating a divergence between economic theory and market reality. This dynamic, coupled with the dollar's diminishing safe-haven status and potential capital outflows, suggests further weakness ahead.
Traders should watch for signs of recession risk materializing, which could initially trigger flight-to-safety flows but ultimately accelerate dollar weakness if growth concerns become the dominant narrative. The dollar's trajectory will also be influenced by the Fed's policy response to tariff-induced inflation versus growth concerns—if the Fed prioritizes growth by cutting rates more aggressively than currently expected, this would likely intensify dollar depreciation. Heightened volatility will create both risks and trading opportunities across currency pairs.
Sources
Fitch Ratings, University of Michigan, Federal Reserve Bank of Philadelphia, S&P Global Ratings, Atlantic Council, Federal Reserve, Reuters, MarketWatch, Trading Economics, Eurasia Group, PwC, Wikipedia, Bureau of Economic Analysis, Economic Report of the President, Forbes, Econoday.