Dollar rebounds from six-week low but tariff worries linger

The U.S. dollar rebounded on Tuesday from a six-week low against the euro, rising 0.9% against the yen, but gains remain constrained amid persistent concerns over the economic impact of the U.S. trade war and tariff policies; U.S. duties on imported steel and aluminum are set to double on Wednesday. Despite upcoming trade talks between Presidents Trump and Xi, analysts note China's increasing leverage and Federal Reserve officials are advocating for cautious monetary policy due to trade-related economic uncertainty, while fiscal worries related to the U.S. debt are also weighing on the dollar.

Analysis

The U.S. dollar showed a tentative rebound on Tuesday, rising 0.9% against the yen to 144.00 and contributing to the euro's 0.6% fall to $1.1371 after the latter had reached a six-week high. This recovery is, however, viewed as limited and overshadowed by enduring concerns regarding the U.S. trade war and its economic impact, with the currency down approximately 9% against the euro year-to-date. U.S. duties on imported steel and aluminum are scheduled to double to 50% on Wednesday, heightening economic uncertainty. While potential upcoming talks between U.S. President Trump and Chinese President Xi Jinping, mentioned by Treasury Secretary Scott Bessent, offer a possibility for de-escalation, reports of China's increasing leverage through control of chip supply chains and rare earths, alongside a denial from China's Commerce Ministry regarding U.S. accusations of trade agreement violations, present a complex backdrop. Domestically, mixed U.S. labor market data for April, showing increased job openings but also a rise in layoffs, underpins the Federal Reserve's cautious stance on monetary policy. Significant fiscal anxieties, highlighted by a proposed tax cut and spending bill expected to add $3.8 trillion to the $36.2 trillion federal debt over the next decade and fostering a 'sell America' sentiment, further pressure the dollar; this outlook is consistent with foreign exchange options market positioning for continued currency weakness. The euro's decline was also influenced by slowing Eurozone inflation below the European Central Bank's 2% target, which fueled expectations for an ECB rate cut later in the week.

Key Decisions for Investors

• Given the dollar's constrained rebound against significant headwinds such as persistent trade tensions, impending tariff hikes to 50% on steel and aluminum, and substantial fiscal deficits, investors should exercise caution regarding new long U.S. dollar positions.
• Closely monitor the outcome of the anticipated Trump-Xi discussions and the market's absorption of the doubled U.S. tariffs, as these events could introduce significant short-term volatility and directional shifts in the currency.
• Consider strategies to hedge against potential further dollar weakness, especially if U.S. economic indicators like the recent mixed jobs data continue to signal a slowdown or if fiscal concerns intensify, aligning with current FX options market sentiment.