The US dollar's recent rally amid concerns about Trump's trade wars and the Fed's potentially hawkish stance was short-lived. Since the end of January, the Dollar Index has fallen more than 4%, and major investment firms have actively revised their forecasts for its future. What exactly is going on?
The idea prevails that the DXY reflects patterns observed during Trump's first term, but the movements seem more driven by news events, such as fears that U.S. protectionist policies could hurt the U.S. economy. Indeed, the Atlanta Fed's estimate for real GDP growth in the first quarter already stands at -2.4%.
The good news is that amidst this economic gloom, there is a silver lining. Suppose the economic situation continues to deteriorate, and the threat of recession looms. In that case, the Fed may be forced to soften its rhetoric — albeit reluctantly — as inflation could still rise due to ongoing trade wars.
Regarding price developments, in February, the Consumer Price Index registered a month-on-month growth of only 0.2%, with a year-on-year growth rate of 2.8%. Meanwhile, the core inflation rate also came in at 0.2% month-on-month and 3.1% year-on-year, slightly above market expectations.
The problem is inflation expectations for next year have risen to 4.9%, marking the highest level since 2022 and representing the third consecutive month of increases. Inflation expectations for the next five years have also jumped by 0.4 percentage points, reaching the highest 3.9% since 1993.
As for the Fed's outlook for interest rate cuts this year, the updated economic projections, commonly known as the “dot plot,” will be released on Wednesday. This will reveal each FOMC member's expectations for future interest rates, and markets are already forecasting three rate cuts this year.
It is also important to note that during his campaign, Trump explicitly stated his intention to weaken the dollar to make U.S. products more competitive abroad. Rumors of an agreement similar to the 1985 Plaza Accord, known as the Mar-a-Lago Accord, are circulating.
Many argue that current circumstances are very different from those of the past, making it difficult for such a plan to come to fruition. Moreover, such actions could trigger a spike in U.S. inflation and, worse undermine confidence in the U.S. currency, leading to greater problems such as de-dollarization.
Bottom line?
With the right course of events, the dollar could still have a lot of ground to lose.