Is the Fed really to blame for the weak USD? - Commerzbank

The reason for the significant strengthening of the US Dollar (USD) in September, when Donald Trump's second term in office was approaching, was obvious. It was widely anticipated that tariffs would push up prices for US consumers and that the Fed would respond with an active monetary policy given the still robust real economy, i.e. it could maintain higher interest rates for longer than the price increase would require. This argument gave the USD an impressive boost, with the dollar index rising by almost 9% in just a few months, Commerzbank's FX analyst Michael Pfister notes.

White House provides many reasons for the USD to weaken

"A number of surveys have indicated concern among consumers and business, but there is still a lack of hard data to substantiate the slowdown in the real economy. Although economic growth in the first quarter was weak, this was mainly due to brought-forward imports. Nevertheless, job creation remains robust and US consumers continue to spend despite high levels of uncertainty. It is therefore no surprise that the Fed is doing its utmost to appear hawkish."

"One argument is that, although the Fed is expected to respond to rising 1Y1Y inflation expectations, many market participants assume that inflation will rise sharply over the next 12 months and then decline. They believe that US tariffs will trigger a temporary rise in inflation. Understandably, the market does not expect the Fed to respond to such a temporary rise in prices, although given the price shock in the wake of the pandemic, one might question whether this would be justified. Nevertheless, a temporary shock would still mean that the purchasing power of the US dollar would decline, justifying a weaker US dollar in such a case."

"Nevertheless, I suspect this only partially explains the US dollar's weakness. Presumably, the US dollar is now reacting more weakly to rising inflation risks because the cause of these risks lies with the White House. In addition to these inflationary risks, the White House provides many other reasons for the US dollar to weaken, such as the risk of imminent taxes on US investment and the generally erratic policies that make investing difficult. But I would argue that, at least for the time being, the weakness of the US dollar is not yet attributable to US monetary policy. Based solely on expectations of the Fed, the US dollar should probably be stronger."