Dollar’s fate hangs on summer’s biggest FX test: Will tariffs reignite inflation?

Investing.com -- The dollar’s fate over the coming months will hinge on whether summer data shows tariffs putting inflation in the driver’s seat or simply delivering a one-off boost that clears the way for the Federal Reserve to resume its rate-cut cycle.
“The USD has depreciated significantly in H1, as economic/policy uncertainty and emerging shifts in global FX exposure render it the key recipient of US risk premium,” BofA strategists said in a recent note.
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Pressure on the Fed to cut has been mounting from the Administration, which has called for lower rates to help curb federal interest expenses—raising questions about central bank independence. “This has added to the USD’s woes, even as markets elsewhere (and inflation expectations) have taken it in stride for now,” according to the analysts.
Despite some dovish signals from Fed Governors Waller and Bowman, and Powell’s openness to cuts if tariff-driven inflation fails to materialize, BofA strategists remain cautious. “Chair Powell… subtly opened the door to a possible dovish shift sooner down the line with comments suggesting that should the expected tariff-induced inflation not show up in the data over the summer, the Fed would likely be able to resume cuts earlier than he originally anticipated.”
Markets are currently pricing in about 28 basis points of cuts by September, but BofA doubts this will be enough to reverse the dollar’s downtrend. “Any unwinding of this pricing is likely insufficient to turn the USD tide… As the overhang of eventual cuts still looms,” BofA adds, pointing out that the dollar’s slide continued in Q2 even as expectations for near-term cuts faded.
The strategists also highlight that the dollar’s latest leg lower has come even as US equities have started to outperform global peers—a decoupling that underscores the risk premium now embedded in the greenback.
For now, inflation expectations remain anchored, but BofA warns that “potential upside risks [are] on the horizon, partly due to possible further Fed dovishness.”
The coming months will be critical for determining whether the Fed can resume its cutting cycle or if sticky inflation will keep the dollar’s slide in check.
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