SUMMARY
The US dollar has partly recovered from its sharp selloff this year. But global investors may no longer have the same appetite for the currency as before.
KEY TAKEAWAYS:
The US Dollar Index has bounced from its April lows
However, recent US policy may have damaged its longer-term standing
We see a mixed outlook for the currency when the tariff pause runs out
The Japanese yen may strengthen further versus the dollar
Investor sentiment toward the US dollar is showing some welcome signs of stabilization. Since late April, the US Dollar Index has bounced from lows of 98.28 to a high of 101.98.
(The US Dollar Index measures the greenback’s value against a basket consisting of the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc.)
This recovery follows a more-than-8% decline from the dollar’s late-February peak. Less uncertainty about the extent of US tariffs has helped fuel the bounce.
But what lay behind the dollar’s previous weakness and what might come next?
The dollar may no longer be perceived as such a “safe haven”
Traditionally, investors have often bought US dollar assets such as Treasuries during times of economic and market stress. That has even been true when the US was at the heart of the turmoil, such as during the financial crisis that originated from the US mortgage market.
However, this has clearly not been the case this year. To begin with, the “US exceptionalism” narrative showed signs of tarnishing from early March.
Investors questioned the previously dominant view that the strength of the US economy, institutions and markets made it a more desirable destination for capital.
Doubts over whether the US would maintain its role as defensive guarantor to many of its allies, especially in Europe, were among the reasons for the shift in narrative.
Next, US reciprocal tariffs – announced in early April – put further selling pressure on the dollar. Again, this caused investors to query the US’s future role in global trade.
The rapid, disorderly decline in the US currency that followed is concerning on at least two counts.
First, it showed that investors can pull money out very quickly indeed when investors lose confidence in US policy settings.
Second, state actors helped to drive the selloff, rather than just private capital. The Chinese central bank and some of its emerging market peers are among those to have shifted somewhat out of dollar assets.
Put simply, the dollar’s “safe haven” reputation has been dented this year. However, we believe the US Dollar Index may still recover to around 103 in the near term. Further trade agreements – such as the US recently reached with the UK – could help drive this.
The dollar’s mixed picture
While peak uncertainty over tariffs may have passed, there is still much that we don’t know.
Three factors are likely to help define the medium- to longer-term view for the currency, in our view.
The first is the extent of any currency agreements struck between the US and select Asian economies as part of a trade agreement. We may learn more about this as the 90-day tariff “pause” comes to an end on July 9.
Next, the drop in US tariffs on China from 145% to 30% significantly reduces the acute risks of higher US inflation. This may provide scope for greater Fed rate cuts than the 50bp that markets currently expect for the rest of 2025. If so, this would likely increase the medium-term bearish tone for the US dollar.
The third factor is how much fiscal tightening occurs via tariffs. Reduced tariffs on China imply less damage to the US exceptionalism narrative. This would be good for the dollar. However, it would also mean the US would take in less revenue from tariffs than was previously expected. This could help drive longer-term US bond yields up and the dollar down.
The combination of these factors leaves the dollar’s outlook clouded in uncertainty, therefore.
Among leading currency pairs, we see a convincing case for the Japanese yen to potentially strengthen against the US dollar over the medium term, with a move toward ¥130.00 and below. But the Euro may struggle to sustain gains above $1.15 this year.
