Dollar outlook murky as trade policies and legislative risks loom
The US dollar's brief rally following the Federal Trade Court’s decision to strike down Trump-era tariffs quickly lost steam after a federal appeals court suspended the ruling until 9 June, leaving the tariffs in place for now. Investors then shifted their attention to Section 899 of the so-called “One Big, Beautiful Bill,” a reminder that US policy uncertainty continues to cloud the economic landscape.
Alongside rising tensions with China, this legislative proposal could present fresh challenges for the dollar. If approved by the Senate, Section 899 would allow Washington to impose taxes on investors and firms from countries that apply what the US deems to be discriminatory tax measures – for instance, digital services taxes or frameworks aimed at curbing low-taxed profits. In practice, this could act as a form of capital restriction, at a time when overseas appetite for US assets is already fragile. If enacted, the policy could erode foreign investors’ returns, potentially accelerating the retreat from US markets – further straining the dollar, already vulnerable due to unpredictable trade manoeuvres and deteriorating public finances.
Nevertheless, the final version of the bill remains uncertain. It has yet to pass the Senate, and crucial questions are still unresolved. It’s unclear, for example, whether income from US government bonds would be excluded. Moreover, the measure appears focused on Western allies like the UK, Canada, Australia, and the EU, while notably leaving out key reserve-holding nations in the Middle East and Asia.
Market sentiment towards the dollar is already cautious, and further downside may be limited in the near term. While traders continue to track developments in trade policy, fiscal direction, and international negotiations, much of the pessimism appears to be accounted for. The dollar’s near-term trajectory will likely hinge on upcoming tariff-related court decisions and a series of key economic releases. Of particular interest is Friday’s May employment report, which will be scrutinised for any signs of how Liberation Day may have influenced job creation, and whether spending cutbacks linked to the DOGE programme are beginning to affect federal hiring.
ECB expected to ease rates as inflation cools
Attention is turning to the European Central Bank’s (ECB) meeting on Thursday, with recent shifts in trade dynamics and tariff-related developments slightly raising the chances of the ECB holding rates steady. Nonetheless, a notable downward revision in inflation forecasts and a faster-than-anticipated drop in headline inflation below the 2% threshold are strengthening the case for a 25 basis-point rate reduction. Ongoing inflation concerns continue to cast a shadow over the economic outlook, further supporting the argument for monetary loosening.
Inflation figures for the euro area, due on Tuesday, are anticipated to show a fall in headline inflation to 2.0% for May. This decline is being attributed to softer energy prices and a reversal of the core inflation spike observed last month, which had been distorted by seasonal holiday and travel expenses linked to Easter. With core inflation likely settling back to around 2.5%, ECB policymakers may see this as an additional reason to lower rates. Such a move could weaken the euro, although the overall effect will depend on how decisively investors anticipate further changes to ECB policy.
A more dovish stance from the ECB, when coupled with easing tensions in global trade and the resolution of recent legal uncertainties, could weigh on the euro against the dollar in the short run. Even so, EUR/USD has climbed back above its 21-day moving average, which has begun to turn upward, hinting that bullish momentum might be returning. Option markets and trader positioning continue to show a preference for euro strength, though near-term fluctuations remain a significant consideration.
Sterling softens as investors weigh outlook and global risks
The pound slipped to $1.35, pulling back from its recent peak of $1.3593 reached on 26 May, as markets reconsidered the UK’s growth prospects and shifting trade conditions. Similarly, GBP/EUR retreated from just below €1.20, with some investors rotating back into the euro in response to heightened global trade tensions and increased currency market swings.
A series of weaker-than-expected US economic indicators, including a first-quarter contraction and rising jobless claims, has led to growing expectations of two interest rate reductions by the Federal Reserve before early 2026. This has created a potentially supportive environment for sterling against the dollar. Still, wider global uncertainty and specific challenges facing the UK economy continue to shape near-term currency movements. The Bank of England remains cautious, guided by solid April retail figures, a rebound in consumer sentiment in May, and persistently high inflation.
Markets currently expect around 54 basis points of rate reductions from the Bank of England over the next year, slightly less than the 60 basis points projected for the European Central Bank. This maintains a roughly 200 basis point advantage in favour of UK rates. With risk appetite stabilising, GBP/EUR has settled at levels in line with interest rate differentials and market volatility indicators, though there may still be room for further gains.
Having posted gains for four straight months, the pound could push higher, especially if investors keep reducing their exposure to the dollar in response to ongoing policy uncertainty in the US. A rise toward $1.3750-$1.40 in the second half of 2025 remains a possibility, provided economic conditions move in the right direction.
