The U.S. dollar’s trajectory in the coming months will largely depend on whether summer data confirms persistent inflation from tariffs or shows a one-time impact that allows the Federal Reserve to resume rate cuts. According to BofA strategists, the dollar weakened significantly in the first half of 2025, largely due to rising economic and policy uncertainty and changing global currency exposures, making it a barometer for U.S. risk sentiment.
Investor focus remains sharply on the Fed’s response to potential tariff-driven inflation. So far, inflation uncertainty has stalled the Fed’s rate-cut cycle, but upcoming economic data could tip the scales. Pressure is also growing from the Biden administration, which has urged the Fed to lower rates to ease government borrowing costs, raising concerns over the central bank’s independence.
Despite dovish signals from Fed Governors like Waller and Bowman, and Chair Powell’s willingness to cut rates if inflation stays subdued, BofA remains cautious. Powell has indicated that if tariff-related inflation fails to persist, the Fed could resume cuts sooner than previously expected.
Markets currently price in about 28 basis points of cuts by September. However, BofA strategists believe this won’t be enough to reverse the dollar’s broader downtrend. Notably, the dollar continued to weaken in Q2 even as expectations for near-term cuts diminished. Interestingly, this decline has occurred despite U.S. equities outperforming global peers—a signal that the dollar now carries a risk premium.
While inflation expectations are still anchored, BofA warns of potential upside risks if the Fed shifts further toward dovishness. The next few months will be key in determining whether the Fed reopens the door to cuts or if inflation proves too sticky to allow further easing.