The narrative in forex for months now has been that the dollar index is losing strength. But, over the last week or so, it has seen a rebound. It’s still off 10% from the highs of the year, but trending upward from a bottom hit back on the 21st of April. The question now is whether this is just a bounce before more downtrend, or are things finally about to turn around?
One of the issues around figuring this out is looking past the popular narrative. The dollar has been weaker at a time when investors have been really concerned about the trade war. So, it’s easy to make the correlation from there. The problem is, the moves in the dollar don’t exactly match up with what’s going on with tariffs, hinting at another issue that could drive the major currency pairs.
When Did It All Start?
The dollar index peaked this year on January 18th, two days before Donald Trump was sworn in. And that was several days before even the first (small) tariff announcements came out. By the time of the massive “Liberation Day” tariffs, the dollar index was already in the red for the year, and actually bounced up a bit a few days later.
The sell-off in the markets that precipitated the shift in risk appetite also does not coincide with a tariff announcement. It coincides with the Fed’s forecast for Q1 GDP turning negative back in mid-February. And where the bulk of the dollar’s losses have been registered is against the Euro, the largest component of the currency basket. Funds are moving across the Atlantic to Europe, weakening the dollar. That is, until last week.
Can We Ignore Trade?
All of this is not to suggest that trade doesn’t have anything to do with dollar weakness. Rather that there are more proximal causes to the dollar’s move, and that might give us better insight into where the dollar will go from here. The concerns about economic growth in the US do spring from worries that the trade war will squeeze the American economy. This has left traders worried about the safety that the US dollar provides, and therefore the greenback is not catching the safe haven flows like usual.
There is another issue: Spending. While DOGE and its efforts to cut spending are highly partisan, as would be expected, currency traders have been worried about the deficit and debt in the US for a while now. The US spends more on interest payments on its debt than it does defense (Social Security is the only budget item that is bigger than interest payments). Congress is grappling with a spending bill that would also raise the debt ceiling to prevent another funding crisis. So far, it isn’t an issue, but the potential of the US to not meet its credit obligations looms, which further weighs on the dollar.
No Easy Fix
On top of that, economists worry that even if a deal is met immediately that resets the trade war, there are still further negative effects waiting. Around 60% of cargo shipments across the Pacific have been cancelled due to the tariffs. Some shipping companies have suspended receiving orders to deliver to the US due to tariff uncertainty. This means that if a deal to end the trade war was reached, businesses would resume their orders creating a supply chain problem that could push prices higher and hurt consumer demand.
As the trade war drags on, this situation will only get worse. Economists are now projecting a recession for the second half of the year. Without a resolution on the trade front, the dollar could remain weaker as traders await the remaining two months of the trade war pause that was enacted mid-April.