U.S. Dollar Suffers Worst Annual Decline Since 2017 as Fed Rate Cuts Reshape Global Currency Landscape

Gerik

Summary:

The U.S. dollar has fallen 9.5% in 2025 its steepest annual drop in nearly a decade amid aggressive Federal Reserve rate cuts and rising concerns over economic management under President Trump...

Dollar Declines Sharply as Fed Leads Global Policy Divergence

In 2025, the U.S. dollar suffered its biggest annual decline since 2017, falling 9.5% against a basket of major currencies. This sharp depreciation was driven by a combination of Federal Reserve interest rate cuts, a Trump-initiated trade war, and growing market skepticism about the dollar’s long-term safe-haven status.

The downward trend began in April, following a series of aggressive tariffs imposed by President Trump on key trade partners. This policy shift eroded investor confidence in the U.S. growth outlook and triggered a sustained sell-off in the dollar, with the currency at one point down nearly 15% before partially recovering.

However, the resumption of the Fed’s easing cycle in September its third in less than 18 months reignited downward pressure. As global central banks like the European Central Bank (ECB) held rates steady or revised growth projections upward, the Fed’s stance increasingly stood out as dovish, prompting further declines in the dollar’s relative value.

Euro and Pound Strengthen as Policy Divergence Widens

The euro led the gains, appreciating nearly 14% to 1.17 USD, its strongest level since 2021. Currency strategists at Deutsche Bank now forecast the euro could climb to 1.20 USD by late 2026. Similarly, the British pound is projected to rise from 1.33 to 1.36 USD in the same period, supported by firm economic data and stable monetary policy from the Bank of England.

This divergence in monetary policy has created a clear cause-and-effect pattern: as the Fed loosens, the dollar weakens, while other central banks standing pat or tightening bolster their respective currencies.

Market Expectations Point to Further U.S. Easing in 2026

Traders now anticipate two to three additional rate cuts from the Fed in 2026, each by 25 basis points. This expectation reflects the Fed’s emphasis on counteracting the economic slowdown and rising unemployment, despite inflation still hovering above its 2% target.

ING’s chief international economist James Knightley commented that the Fed is “clearly in a loosening phase,” diverging from its global peers, and that this policy stance is likely to continue pressuring the dollar through 2026.

Trump’s Economic Policy Sparks Currency Market Volatility

Investor anxiety has also intensified amid speculation over President Trump’s influence on Fed leadership, as Jerome Powell’s term ends in May. One top contender, Kevin Hassett, is seen by many in markets as more aligned with Trump’s interventionist economic agenda. Analysts warn that if the next Fed chair is perceived as overly accommodative or politically motivated, the dollar may face deeper losses.

According to a Financial Times report, bond investors recently voiced concerns to the U.S. Treasury over a Fed potentially dominated by Trump allies, citing fears of more aggressive rate cuts and unpredictable policy behavior.

Hedging Rises as Investors Reassess Dollar Exposure

The weakening dollar has had mixed implications. It has benefited U.S. exporters, whose goods become more competitive abroad, but hurt European firms reliant on revenue from American markets. Meanwhile, foreign investors are increasingly hedging their dollar exposure when buying U.S. equities, reflecting heightened sensitivity to exchange rate risk.

George Saravelos of Deutsche Bank noted that a growing number of European investors are deploying currency derivatives to manage dollar volatility, a trend that itself reinforces downward pressure on the greenback.

Resilient Tech May Cap Dollar Losses

Despite macro uncertainty, some analysts remain cautiously optimistic. SocGen strategist Kit Juckes argued that while Trump’s policy unpredictability may weigh on sentiment, continued investment in AI and tech in the U.S. could support faster growth than Europe and limit the scope of further dollar depreciation.

Still, many warn that equity gains alone will not necessarily translate into currency strength. If foreign investors continue hedging and capital inflows soften, the dollar’s structural outlook remains fragile.

Dollar’s Dominance Challenged as Monetary Landscape Shifts

The U.S. dollar ends 2025 under significant pressure, weakened by aggressive Fed easing, political uncertainty, and shifting global capital flows. While some recovery was seen after September’s low, the broader trajectory remains bearish heading into 2026.

With new Fed leadership on the horizon and further cuts priced in, investors are reassessing the dollar’s role as a safe-haven and global benchmark. Whether Washington’s policy shifts signal temporary volatility or a long-term weakening of the dollar’s dominance will depend heavily on what unfolds in the year ahead.

Source: FT

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