USD - Where is it going?

The USD has been on a depreciating trend since the start of this year, with a 10.70% decline in the dollar index (DXY). Let's have a quick look at why and the potential outlook.

DXY: The dollar index is a measure of the value of USD relative to a basket of foreign currencies, including EUR, CHF, JPY, CAD, GBP and SEK - the 6 most significant trading partners of the US. It has a base of 100, meaning an index of 120 and 80 would mean a 20% increase and decrease in the USD strength relative to the other currencies, respectively.

Basic principles: Fluctuations in the strength of a currency are determined by demand and supply of that currency relative to the other currencies. The higher the demand for a currency, the higher its "price" - the stronger the currency. Note that the strength of a currency is always relative to another.

• Demand is affected by factors including interest rates, exports, political stability, safe-haven status for USD - all of which determine whether individuals/investors purchase more USD. 
• Supply is affected by monetary and fiscal policies, foreign investments, and imports.

Quick background; DXY climbed from ~100 to ~110 from October 2024 to January 2025 as Trump won the US election. The appreciation of the USD was primarily due to market expectations of the policies he advocated for and proposed. These include tax cuts (higher profits, investment), increased government spending (driving demand), and tariffs (trade balance).

Looking at key factors affecting currency value:

1. Demand side
1. Economic performance: Better-performing economies tend to have stronger currencies, due to continued growth, positive trade balance, high GDP growth and foreign investments etc.
2. Interest rate: A country with higher interest rate tends to appreciate relative to a country with lower interest rate as higher rates attract foreign investment and provides better returns. 
3. Inflation: A country with high inflation erodes the purchasing power of the currency, thus less attractive to investors and depreciate relative to other currencies.
4. Government debt: High levels of government debt erodes investor confidence in a country's financial stability and its ability to repay its debts and ultimately depreciate the currency value.
   
   
2. Supply side
1. Monetary policy: Central banks regulate the money supply in the economy via open market operations (i.e. buying/selling of government securities). Lower supply of money in the economy would drive up interest rates and hence the currency would appreciate.

These factors are closely intertwined as currency strength is affected by just about anything - it is the most "macro" security in the market. 

So why has the USD fallen YTD?

1. Interest rates: Inflation and rate cuts have been the hottest topic in the market in recent years post-Covid. Fed has started to lower its interest rates in 2024 as prices stabilise, thus making dollar-denominated assets less atractive compared to those in other countries with higher rates.
   
   
2. Gloomy geopolitical and economic outlook: Economic slowdown has been the norm around the world. Additionally, with the Trump tariffs that was launched earlier this year, trade outlook has worsened for US and the global economy. Coupled with the wars happening now, this then deters foreign investments.
   
   
3. Political uncertainty: The expected increase in government debt due to the Trump administration's policies also erodes investor confidence in the US economy. This led to Moody's' downgrade of its credit rating from Aaa to Aa1, the last triple-A credit score from a major international ratings firm. This does not bode well given that interest on government debt rises with a lower credit score. With debt of USD36tn, investors are calling it the "debt death spiral".
   
   
4. De-dollarisation: This decoupling of the USD is intertwined with all the above. USD as a reserve currency has lost some of its dominance as other countries like China, Russia and India have started to reduce reliance on the USD. This is a significant push in the depreciation of the dollar.

The outlook for the dollar does not look bright. What could reverse this downward trend?

1. Interest rates: Rates must rise again for USD to appreciate. This depends greatly on:
1. The Fed chairman who makes decisions on the rates. Powell's term comes to an end in May 2026, following which, Trump would then be able to nominate the next chair. Trump is currently pressuring Powell to cut rates to spur business, and despite the need for independence of the central bank, we may see the next Chair be more willing to cut rates which will cause further depreciation of the USD.
   
2. Inflation has been hovering at 2-3% for almost 12 months now, but Powell would like to see more data before deciding to cut rates. With the recent tariffs and oil price spikes, we may see a persistent inflation, thus delaying any rate cuts for now. 
   
   
2. Gloomy geopolitical and economic outlook: USD has typically been seen as a safe haven for investors in times of uncertainty. With the escalation of conflict in the Middle East today, however, we have not seen that flight to the USD. Instead, oil and gold surged 7% and 1.5% respectively. Other currencies viewed as safe havens have also appreciated, including CHF, JPY  and SGD. 
   
   
3. Political uncertainty: The US government needs to address its growing national debt and inconsistent stance on its policies to regain investor and consumer confidence. 

In my opinion, it seems likely that the USD will continue sliding as long as current events continue and Trump retains his usual approach to geopolitics and the economy. Upsides to the USD are there but possibility seems to be muted. Let's see where the dollar goes in H2 2025.

2nd July 2025: DXY is at 96.934.