This recent decline reflects growing investors’ uneasiness about the direction the Fed will move next and whether its current strategy is sustainable in the case of economic signal shifts.
Since the beginning of 2025, the Fed has kept its benchmark interest rate within the range of 4.25% to 4.50%. The high rate is part of its efforts to curb inflation, which has hovered over the Fed's 2% target. By increasing borrowing costs, the Fed aims to reduce consumer spending and control inflation. However, signs of economic slowdown are becoming increasingly difficult to ignore.
Despite these warning signs, the market does not expect the Fed to lower interest rates at this week's policy meeting. Investors allocated only three 1-inch chances to lower tax rates at their next major meeting in June, highlighting the uncertainty now that now clouds the FedWatch process and the way forward for the dollar, according to CME Group’s FedWatch tool.
The return of trade tensions is increasing. In early April, President Donald Trump announced "reciprocity" tariffs against U.S. trading partners. Although these new tariffs have not been implemented, their announcement alone has already undermined financial markets and sparked anxiety among investors and policy makers.
Economists warn that even if these tariffs are lowered before implementation, they can still weaken economic growth and drive higher inflation. This will make the Fed's work even more complicated as it tries to balance controlling inflation with throwing the economy into recession.
These developments are particularly worrying because they come at a time when the post-pandemic recovery phase of the U.S. economy has slowed down. When import costs due to tariffs are high, slow growth can pose a double challenge: demand weakens when prices are raised.
One of the key reasons behind the dollar's current weakness is the growing gap between hard and soft economic data, a disconnect that has caused investors, analysts and central banks to scratch their heads.
Hard data consists of specific data such as GDP growth, unemployment, manufacturing output and retail sales. These indicators reflect past performance and show us what has happened in the economy. So far, these data continue to show a rather strong economy. Job creation is stable, consumer spending is relatively flexible, and industrial activity has not yet dropped significantly.
On the other hand, soft data reflects how people and businesses think about the economy. It includes surveys on consumer confidence, business prospects and inflation expectations. These indicators are forward-looking and try to predict what will happen next.
Currently, the stories told by soft data are even more frustrating. Consumer confidence is vanishing, and many businesses report growing concerns about future sales, recruitment and investment. This difference between perception and reality creates a blurry picture of the real health of the American economy.
For investors, this ambiguity has become the source of concern. The decline in the dollar may partly reflect a growing belief that sentiment (usually a leading indicator) will soon delay hard data.
The Fed is now facing one of the most delicate balancing behaviors in decades. On the one hand, hard data tells a story of sustained resilience. On the other hand, the mood became grim in the streets and on the board. The key question is, of course, whether the Fed should now respond to warnings in soft data or wait for the exact evidence of slowing down?
If the Fed lowers interest rates prematurely, it could reignite inflation and revoke many progress in the past year. But if it waits too long, it could lag behind the curve and plunge the economy into a deeper recession.
According to the Baker-Bloom-Davis, the index tracks uncertainty in U.S. monetary policy, and investors' anxiety about what the Fed will do is now at its highest level since 1985, which prescribes a pandemic. This makes this one of the most unpredictable moments in recent U.S. economic history.
Goldman Sachs economists believe the Fed will change its priorities soon. The company predicts a three-tax reduction in July, September and October, believing that a gentle economy will eventually prompt central banks to take action even if inflation has not yet fully recovered to target.
Over the years, the US dollar has risen from positive interest rates, a relatively strong economy and its long-standing status as a world security currency. But this narrative begins to change.
As interest rates may approach peaks and economic uncertainty grows, the dollar's advantage begins to disappear. With speculation about the upcoming tax cuts, the dollar has lost its appeal to global investors seeking higher yields and stability.
Now, many are looking for diversified stakes. Currencies in Europe and emerging markets are attracting attention, with the euro, pound, Swiss franc and yen also violating the US dollar. Since the beginning of this month, Taiwan’s US dollar has seen a huge growth rate compared to the US dollar, with nearly 10% growth in recent trading days reaching a three-year high.
This shift is not just interest rates, it is a broader reassessment of global opportunities. If the United States slows down while stabilizing or growing in other regions, capital may flow elsewhere, further putting pressure on the dollar.
This article was originally published on FX Empire