Mounting headwinds threaten U.S. dollar momentum

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Welcome to Advisor to Go, brought to you by CIBC Asset Management, a podcast bringing advisors the latest financial insights and developments from our subject-matter experts themselves. 

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Eric Morin, director of global macro and strategy for the multi-asset and currency management team at CIBC Asset Management 

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Factors that are causing the U.S. dollar to weaken, we see several of them. 

So, first of all, we have the combination of tariffs and monetary policy that is currently tight and that should lead to growth deceleration in the next few months. So we’re talking about the end of 2025, and early 2026. 

That should force the Fed to resume its renormalization cycle of its monetary policy, cutting its policy rate towards neutral. And we do believe that this should contribute to a weaker U.S. dollar. 

In terms of tariffs, this is an important headwind for the U.S. economy. The U.S. has, as we all know, implemented the largest tariff increase in nearly a century, and this is creating concentrated headwinds for U.S consumers and U.S. companies. Someone will have to pay the tax, and we do think that the U.S. consumer will have to pay a tax of high tariffs, and this is something that should weigh negatively on consumption. 

And so, net the combo of tariffs and tight monetary policy should reduce economic growth by about one percentage point over the next 12 months. So, in a world without tariffs and with less restrictive monetary policy, growth would be one percentage point higher than what we expect in the next 12 months. 

So, our outlook for the Fed cut — until mid-2026 — has remained for 100 basis points. We’re currently debating if we should increase that number. The point is that the Fed has been a laggard in terms of policy cuts globally, and the tariff shock and the slowdown of labour markets should force the Fed to cut by at least 100 basis points in the next 12 months. 

So this is why we do see a weaker U.S. dollar. 

The second point is the increasing institutional risks regarding U.S. institutions. So we have, on one hand, fiscal deficits that are elevated at 6%, 7% of GDP. This is much larger than most developed market countries, about two or three times larger in certain cases. And the debt path is elevated in the U.S., and the long-term outlook is really for a sharp increase.  

So ballooning debt is something that is a long-term theme that is clouding the outlook for U.S. treasuries in the sense that foreign investors — so non-U.S. investors — are becoming a little bit concerned about the long-term fiscal sustainability of the U.S. 

So in the past, the amount of concern was probably zero. Moving away from zero to some concern is something that should weigh negatively on the demand of U.S. Treasuries, and ultimately the U.S. dollar. 

We do believe that institutional risk is a reason why we’ve seen a rise of the U.S. term premium in the U.S. So this is the part of longer-term interest rate that is a compensation to investor to bear the duration risk. And that term premium has been increasing, suggesting slowing demand from abroad. This is a thematic that should remain a lingering headwind for the U.S. dollar, we believe, partly also because several institutional investors outside the U.S. will have more appetite to de-risk from excessive exposure of U.S. assets in their balance sheet. That should bring some downside pressure on U.S. Treasuries demand, and also the U.S. dollar. 

Another headwind for the U.S. dollar is growing concerns about the independence of the Federal Reserve. U.S. President Trump has recently threatened to fire members of the FOMC, so the committee that conducts monetary policy. And those threats should undermine confidence in U.S. institutions. And this is an issue because, typically, that kind of political interference is something that is generally seen in emerging markets. 

So that threat to the independence of the Federal Reserve is, we believe, a long-term concern for certain institutional investors, especially institutional investors in developed markets, which will likely have lower appetite to hold an excessive exposure of U.S. assets in their balance sheets. So we’re talking about perhaps central banks, for example. There are also institutional investors, pension funds. So we do see that the concerns about the independence of the Fed is something that should lower the appetite of U.S. assets, especially U.S. Treasuries by foreign investors. 

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Are markets fully pricing the Fed’s rate path? And could we see surprises that could cause large U.S. dollar swings? So as of now, we are in late August 2025. For the next 12 months, markets are pricing almost five cuts of 25 basis points. In recent weeks, the pricing has been hovering between four and five cuts. That pricing looks reasonable, and the fact that the Fed should cut by that amount — and perhaps more — this is something that should weigh negatively on the U.S. dollar. 

So, this is something that is priced on the rate side. For the currency, it’s not clear that this is something that is embedded in the price of the U.S. dollar. The reason being that there is a lot of uncertainty surrounding what the Fed will be able to do. In other words, there are fat tails surrounding the baseline outlook because there is big risk. 

So what could go wrong? Well, we could be in a situation where we could see positive surprises on the U.S. dollar, if the U.S. economy doesn’t slow as expected, forcing the Fed to cut less than what’s priced. So this is a risk that is still there. The Fed may not be able to cut what’s priced because the U.S. economy may simply remain more resilient, and/or inflation could remain stickier with the larger passthrough of tariffs than widely expected. That could make the Fed more reluctant to deliver what’s priced. So there is an upside risk there. It’s not our baseline, but this is something that is limiting that downside pressure on the U.S. dollar. 

The other aspect, also in terms of risk, there is also a downside risk where the U.S. dollar could depreciate more because the Fed may be forced to cut more than what’s priced. So there’s a big tariff shock that is coming. Monetary policy is tight. The balance of risk is skewed to the downside for the U.S. economy. So we can be in a situation where weaker growth could result in a weaker U.S. dollar. 

So, there is a lot of uncertainty there. But really, I would say the biggest concern for markets is the fact that the Fed may not be able to cut what is priced right now due to inflation and/or growth and, as a result, this is something that is a risk. And so we may have to wait a little bit more before seeing more downside pressure on the U.S. dollar.  

Perhaps what could be the catalyst of renewed downside pressure on the U.S. dollar is a genuine slowdown of job creation, which is something we expect to take place in the fourth quarter of 2025 and in early 2026. That should reinforce what is priced, and should also result in the U.S. dollar’s weakening resuming. 

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So how does U.S. dollar exposure impact return for Canadian investors? And should Canadian investors consider hedging? The short answer is that the U.S. dollar outlook should be a headwind for Canadian investors. 

Canadian investors own a lot of U.S. assets in their portfolio, and they should do. But the U.S. dollar risk and the downward pressure that we see makes U.S. assets less attractive. So, yes, the U.S. dollar exposure is something that should reduce the attractiveness of U.S. assets for Canadian investors, and non-U.S. investors in general. 

So as a result, we do believe that investors should consider hedging in their investment decisions. This is especially the case in a context where the U.S. dollar seems to be becoming slightly more cyclical. So when we talk about hedging, it’s not necessarily moving away from a non-hedged portfolio towards something that is fully hedged. But we’re talking about perhaps a partial hedge, or dynamic hedging strategies that may offer a risk-reward balance between some sort of a currency risk and currency headwind, and also balanced with the fact that U.S. stocks remain attractive from a fundamental standpoint. 

It’s important to keep in mind that the U.S. dollar is the global reserve currency, and it should remain. So we have a negative outlook for the U.S. dollar. It will be a less attractive global reserve currency, but it will remain by far the dominant currency down the road.

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