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Fiscal dominance could drive dollar even lower Markets valorinternational.txt
Although the DXY index has already fallen more than 10% this year,flow poker show the U.S. dollar is expected to continue depreciating against major peers. Initially, President Donald Trump’s trade policy was blamed for the decline, but now the imminent monetary easing cycle by the Federal Reserve is seen as the main driver of further weakness. Adding to the pressure is a narrowing interest-rate differential—broadly negative for the dollar—and growing market chatter about fiscal dominance, which could also weigh on the currency. In a note to clients, Deutsche Bank’s global head of FX research, George Saravelos, warned that markets are “too complacent” about fiscal dominance. He argued that risks should already be visible in long-term breakeven inflation and in a deeper dollar discount—neither of which has materialized. “We find no convincing argument why markets should not be pricing this risk more aggressively,” he wrote. Mr. Saravelos cited risks to Fed independence, pointing to the recent resignation of board member Adriana Kugler—who stepped down before the last policy decision without voting—and legal challenges surrounding Governor Lisa Cook, whom Mr. Trump has sought to dismiss. “There is no doubt, in our view, that the Fed is now subject to growing fiscal-dominance risks,” Mr. Saravelos said. “Recent macro news flow has been negative for the dollar: the U.S. faces a combined negative demand shock (tariffs) and supply shock (immigration), with Fed independence potentially compromised.” Rabobank senior FX strategist Jane Foley explained why the dollar has not yet reflected these risks. According to her, the perception is that President Trump’s potential nominees would not “blindly” follow his orders, preserving some credibility at the central bank despite eroded independence. “Even though losing central bank independence is really bad, I think it’s more likely we’ll see only moderate dilution of that independence, with some doves on the board,” Ms. Foley told Valor. “That doesn’t mean they would blindly follow Trump in the event of inflationary shocks.” She added that this credibility explains why the dollar has not fallen more sharply, pointing to credible candidates to succeed Jerome Powell, such as former Fed Governor Kevin Warsh, former White House adviser Kevin Hassett, and current board member Christopher Waller. Jane Foley of Rabobank: "Even though losing central bank independence is really bad, I think it’s more likely we’ll see only moderate dilution of that independence, with some doves on the board" — Foto: Reprodu??o/BloombergTV Still, Ms. Foley acknowledged that a broader fiscal-dominance scenario is possible, one in which markets would have to pay closer attention to government spending. Similar concerns are already visible in developed markets like the U.K. and France, where long-term yields have reached multi-decade highs. Even so, she expects the U.S. to suffer less than peers, thanks to the exceptionalism of its economy. “Global investors cannot really avoid buying U.S. assets,” she said. “Things may have shifted somewhat with this year’s market rotation, which has left Treasuries more vulnerable than last year, for example.” In the U.S., a sharper rise in long-term rates amid fiscal and trade uncertainties could create unusual dynamics for the dollar, Ms. Foley noted. “Normally, Fed rate cuts are negative for the dollar. But sometimes, as in this case, moves in long-term yields can have a more dramatic impact on FX,” she said, pointing to the DXY’s temporary strength during recent Treasury-market turbulence. Ms. Foley expects the dollar to trade sideways through year-end, with cuts already priced in and heavy short positioning in the market. But in 2026, she projects renewed weakness if the Fed adopts a more dovish stance. Rabobank’s baseline is one cut in September and four in 2026, with the euro potentially reaching $1.20, though gradually. Swiss private bank Lombard Odier also forecasts dollar depreciation over 12 months, with the DXY falling toward 91. Its baseline scenario calls for three Fed cuts this year and three more next year, taking rates to 2.75-3.0%. While narrowing rate differentials are a catalyst, Lombard strategist Kiran Kowshik stressed that the macro environment in which the Fed is cutting rates is also dollar-negative. “The Fed will be easing while other central banks have already completed their cycles. But the context is different. Historically, when the Fed cut rates while long yields were rising, the dollar did not perform well,” Mr. Kowshik said. He expects U.S. fiscal concerns, curve steepening, and narrowing rate spreads to benefit both emerging-market and developed-market currencies against the dollar. Lombard Odier projects the dollar to weaken against the yen over 12 months, to around 130-140 per dollar. By contrast, Mr. Kowshik sees a more stable outlook for sterling, constrained by the U.K.’s limited fiscal space and the perception that the pound is overvalued. Lombard’s projection puts the dollar near ￡1.37. This article was translated from Valor Econ?mico using an artificial intelligence tool under the supervision of the Valor International editorial team to ensure accuracy, clarity, and adherence to our editorial standards. Read our Editorial Principles.
