The beginning of the end for the US dollar?

The announcement on 2 April of 10% baseline tariffs on all US imports plus higher reciprocal tariffs on imports from selective countries had a major impact on financial markets. International equity prices initially fell by more than 10% in the days immediately following the announcement, while implied volatility on S&P500 options soared to its highest level since the start of the pandemic. The announcement on 9 April of a 90-day pause in punitive reciprocal tariffs brought some calm to equity markets, helping them recover about half of the losses of the previous days.

Currency market volatility has also risen (see Chart 1), with the US dollar the main loser. The dollar’s trade-weighted exchange rate has fallen 4% since the beginning of April, with the decline accelerating after the 90-day pause announcement.

Chart 1. FX volatility on the rise

Source: LSEG Data & Analytics and EFGAM calculations. Data as of 11 April 2025.

The dollar’s decline following the tariff announcement surprised many observers. Economic theory suggests that if a country imposes tariffs on imports, its currency should appreciate. The theory predicts that this should reflect lower demand for foreign currency following the drop in imports and the expectation of higher domestic inflation and interest rates than in countries subject to the trade tariffs.

Chart 2. Yield differential and EUR/USD exchange rate

Source: LSEG Data & Analytics and EFGAM calculations. Data as of 11 April 2025.

One explanation for the decline in the US dollar is that policies proposed by the Trump administration have undermined the US’s credibility as a reliable partner, not just in trade but also in other spheres such as defence and with regard to supporting the international order more broadly. The divergence between the US-eurozone interest rate differential and that of the EUR/USD exchange rate suggests that this process is underway (see Chart 2). As during the first Trump administration, the relationship between these two variables appears to have broken down in recent months. 

If this is the case, it is not surprising that international investors want to reduce their exposure to US assets and the dollar. The new record gold price is consistent with this view. 

US dollar weakness also reflects the observation that it still appears moderately overvalued according to Purchasing Power Parity (PPP). Looking at the euro and the Swiss franc, the valuation gap is between 3% and 6% (see Chart 3 a and b), but it is around or above 25% against the Japanese yen and the British pound. The Swiss franc, like the yen and gold, is supported by its safe haven characteristics that stimulate demand in times of economic uncertainty and market volatility.  

What could interrupt the weaker US dollar trend? 
In the short term, any steps taken by the US administration that help restore credibility, trust and predictability would likely support the dollar. If the underlying problem is market scepticism about the effectiveness and necessity of trade tariffs, any actions that calm this caution could be well received by markets. An announcement, perhaps in the next few days, that reduces market concerns about the economic repercussions could help stabilise the currency market. In the absence of such an announcement, it cannot be ruled out that the EURUSD exchange rate will rise towards 1.20 and the USDCHF exchange rate will fall towards 0.75. News over the weekend that mobile phones and laptops will be excluded from tariffs for the time being represent a step in the right direction. 

Separately, some central banks, notably the European Central Bank and the Swiss National Bank (SNB), will be concerned both with the speed of the move in the dollar and also the extent of the decline. This may encourage both central banks to adopt a more dovish policy stance, which in the case of the SNB will likely include currency market interventions, to offset the disinflationary impact of a strong euro and Swiss franc.

The medium-term implications of the recent developments point to a reduced role for the US dollar within the international financial system, including a smaller share in central bank foreign currency reserves. However, this will play out over years as there is currently no credible alternative that could replace the dollar.

Our expectation is that following this period of adjustment and volatility, US dollar bilateral exchange rates will continue to be strongly influenced by business cycle fundamentals, including GDP growth, inflation, interest rates and the state of public finances. Ultimately, it will be the economic policies adopted by governments around the world in response to the Trump administration’s actions that will determine the medium-term trends on the currency market.