Navigating the dollar’s future under Trump’s tariffs

The US dollar has weakened since the Trump administration announced its import tariffs on 2 April, as markets factor in the risk of a slowing American economy and higher inflation. In March, we shifted from a positive to a neutral stance on the US dollar against developed markets, represented by the DXY basket of currencies. Instead, we favour havens such as the Swiss franc and Japanese yen.

The dollar has continued to slide since 2 April, reflecting much larger than expected US tariffs. Markets are interpreting the tariffs as a stagflation risk (stagnant growth, rising inflation) for the US economy. By implication, US tariffs are considered less damaging for the rest of the world, at a time when investors have high allocations to US assets and may be prompted to sell them.

For now, US consensus growth estimates are falling. At the beginning of 2025, forecasts pointed to 2.2% gross domestic product growth, which were revised to between 1.5% and 2.0% before 2 April. Since the tariff announcements, gross domestic product (GDP) forecasts have been slashed further with some even suggesting that a recession is possible. Our own revised 2025 US GDP growth forecast is higher than this consensus at 1.2%, compared with 1.8% prior to “Liberation Day,” and 2.4% at the start of the year.

However, we do not expect the rest of the world to escape negative impacts on growth, especially if trade partners retaliate by raising their own tariffs. Signs of this were visible towards the end of last week, when the US dollar began to recover as global markets fell in response to China’s counter tariffs. Historically, the effects of a slowing US economy have spilled over to the rest of the world, weighing on global growth and strengthening the dollar against most currencies, with the exception of traditional havens such as the Japanese yen and Swiss franc.

We do not expect the rest of the world to escape negative impacts on growth, especially if trade partners retaliate

Weaker dollar conditions are not clear cut

For the US dollar to stay weak against growth-sensitive currencies such as the euro, as in 2020 or even in 2016-2017, two pre-conditions are necessary. First, a ‘push’ factor in the form of a shrinking US-foreign yield differential, and a ‘pull’ factor of strong foreign growth compared to the US. The latter has often been driven by strong Chinese stimulus measures (see chart 1).

We expect neither of these factors. We see the Federal Reserve cutting its interest rate to 3.75% at the end of 2025, instead of 4%, and the European Central Bank’s rate reaching 1.5% at the end of their rate cutting cycle, with the Swiss National Bank reaching 0%. This would maintain a wide interest rate differential in the US dollar’s favour – of 225 basis points against the euro, and an unchanged 375 bps against the Swiss franc.

US equity purchases by foreign investors do not show a strong correlation with the dollar

Potential outflows from US equities?

What about capital outflows from the US? The prospect of capital re-allocation away from the US to other regions, and subsequent dollar depreciation, has gained some traction. But US equity purchases by foreign investors do not show a strong correlation with the dollar (see chart 2). The sale of US Treasuries by international investors in response to the tariff war would only makes sense if longer term US bond yields were expected to rise, and lead to negative returns for investors. On the contrary, we expect US 10-year Treasury yields to fall slightly further, and below 4%. This should help expected returns from US Treasury holdings remain positive. For this reason, we do not expect fixed income flows to add US dollar weakness for now.

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We believe that risks to our neutral dollar index view are two sided. On the downside, sharper Fed rate cuts, compared to the ECB and Bank of England, would narrow short-term interest rate differentials, and strong Chinese stimulus would eventually weaken the dollar. This could in turn see the EURUSD rise towards a longer-term fair value of 1.15 – 1.20. Conversely, lower growth elsewhere and more stable US growth expectations (for example thanks to a stronger labour market, or improvements in trade and current account imbalances) could see the dollar recover, with EURUSD returning to 1.06, close to the middle of its two-year, 1.02 – 1.12 range.

Both the Japanese yen and Swiss franc are undervalued and act as havens in periods of uncertainty

While our view on EURUSD and the broader dollar index is more neutral, we have a preference for haven currencies like the Swiss franc (CHF) and Japanese yen (JPY). Both currencies are undervalued (see chart 3) and act as havens in periods of uncertainty, which we expect to remain the dominant driver rather than country specific drivers like the view on the SNB and Bank of Japan. We see risks to our current USDJPY and USCHF (currently 144 and 0.85 respectively) as tilted to the downside.