Why the dollar isn't rising on tariffs

Economic textbook orthodoxy dictates that when a large economy imposes across-the-board tariffs, its domestic currency must appreciate to restore external balance. A stronger exchange rate theoretically neutralizes border levies by cheapening foreign goods at the port of entry. Yet the US Dollar Index has stalled near 108, retreating from cyclical highs above 110 even as trade rhetoric escalates into active policy decrees.

The Broken Offset Mechanism

The standard macroeconomic assumption of automatic currency offset relies on frictionless capital flows and isolated tariff shocks. In 2025, foreign exchange markets are not treating US tariff actions as isolated commercial policies, but as self-inflicted terms-of-trade degradations that threaten domestic growth and elevate sovereign inflation risk. Global investors are unwilling to bid up the dollar when the levies simultaneously raise domestic production costs and jeopardize international supply networks.

Retaliation and Capital Flight

Furthermore, the specter of coordinated foreign retaliation and non-tariff countermeasures creates an asymmetric downside risk for dollar-denominated assets. Foreign sovereign wealth funds and central banks are actively diversifying reserve allocations into non-dollar liquid alternatives to insulate their treasuries from potential weaponized financial sanctions. When tariffs depress domestic productivity and provoke systemic global friction, the foreign exchange market refuses to play its textbook balancing role, leaving the dollar vulnerable despite rising protectionist barriers.