Why the dollar isn't rising on tariffs

The US Dollar Index has stalled near 108, down from cyclical highs above 110, even as the administration's trade threats turn into actual decrees. Textbooks say this should not happen. When a large economy slaps tariffs on everything it buys, its currency is supposed to rise and restore external balance, because a stronger exchange rate makes foreign goods cheaper at the port and offsets the levy.

From threat to decree

The decrees have come thick and fast. A 10 per cent duty on Chinese goods took effect last week, levies on Canada and Mexico were suspended only after last-minute concessions, and on Monday the president signed orders for 25 per cent tariffs on imported steel and aluminium. The index peaked in mid-January, before any of this had happened, and has drifted lower as the measures moved from campaign promise to executive order. More is promised: the president has said he will set out reciprocal tariffs, matched to each partner's own duties, within days.

Why the offset failed

That automatic adjustment assumes capital moves freely and the tariff shock arrives on its own. In 2025 neither holds. Currency traders are treating American tariffs as a self-inflicted blow to the country's terms of trade, one that threatens growth and raises the risk of inflation. Investors see no reason to bid up the dollar when the same levies push up domestic production costs and put international supply chains at risk.

The textbook mechanism runs through trade flows. Tariffs cut purchases of foreign goods, so American importers sell fewer dollars for foreign currency, and the exchange rate rises until the cheaper foreign price roughly cancels the duty. Daily currency turnover dwarfs the value of goods trade, however, so what moves the dollar in practice is where investors want to hold assets, and a policy that raises the odds of slower American growth makes them less keen.

Equity flows show the shift. For two years money poured into American shares on the belief that the country's growth and technology companies would outpace everyone else's. Since the start of this year European stocks have done better than American ones, helped by cheap valuations and a sense that the worst of Europe's energy shock is over. A foreign investor who trims an American equity position sells dollars as well as shares, and that alone can offset the trade-flow support the textbook predicts.

The 2018 comparison

The offset did appear in the last trade war. As American duties on Chinese goods escalated in 2018 and 2019, the renminbi weakened and in August 2019 passed 7 to the dollar for the first time since 2008, prompting the Treasury to label China a currency manipulator. That weakening absorbed part of the tariff for American buyers. This time the targets are more numerous and include close allies, and there is no single currency whose fall can cushion the blow.

Who gains from a stalled dollar

A flat dollar redistributes the tariff bill. If the currency had risen to cancel the duties, foreign exporters would have borne much of the cost through a weaker home currency, and American shoppers would have noticed little. With the dollar stuck, the importer pays the duty in full and passes what it can to customers, so the burden shifts towards American households and firms. The winners are American exporters, whose goods stay competitive abroad, and emerging-market governments and companies that borrow in dollars, for whom a steady exchange rate means debt service does not balloon.

Reserve managers look elsewhere

The prospect of coordinated retaliation abroad, including measures that go beyond tariffs, adds to the downside for dollar assets. Foreign sovereign wealth funds and central banks are moving part of their reserves into liquid alternatives outside the dollar, partly to protect themselves from sanctions that Washington might one day aim at them. The freezing of Russia's central-bank reserves in 2022 made that risk concrete, and central banks have bought more than 1,000 tonnes of gold in each of the past three years. The dollar's share of global reserves has been drifting lower since the turn of the century.

The case for a firm dollar

The strongest objection is that the offset has already happened. The index rallied hard between the autumn and mid-January as markets priced in the tariff programme and a slower pace of Fed cuts, so the current stall may be a pause after the adjustment rather than a failure of it. Interest rates also still favour the dollar: the Fed has held its policy rate at 4.25–4.5 per cent, while the European Central Bank cut its deposit rate to 2.75 per cent at the end of January. There is also the matter of intent. Stephen Miran, the president's choice to chair the Council of Economic Advisers, has written about ways to push the dollar lower, and markets may be pricing that preference too.

Miran's paper, published in November, discussed using tariffs and security guarantees as leverage to persuade allies to accept a weaker dollar, a deal some have called a Mar-a-Lago Accord in an echo of the Plaza Accord of 1985. At the Plaza the big economies agreed to sell dollars together, and the currency fell sharply over the following two years. Nothing of the kind is on the table yet. If traders believe the administration wants a softer dollar and will tolerate one, they have little reason to fight the tariff logic by buying it.

Signals to watch

January's consumer price figures, due this week, will show whether tariff fears are feeding into inflation fast enough to delay Fed cuts, which would support the dollar. Jerome Powell's testimony to Congress this week will show how patient the Fed intends to be. Any sign that allies are coordinating retaliation, or that reserve managers are cutting Treasury holdings, would push the other way. A break back above 110 would suggest the textbook was only running late.

For now the arithmetic falls on buyers at home. The currency market has declined to do the job the textbook assigns it, so American importers and consumers will probably absorb most of the tariffs themselves, with no help from a stronger dollar for as long as the trade fights continue, and the first place it shows will be in goods prices over the spring.