The US dollar retraced almost all of its recent gains following trade-related developments with China, impacted further by the publication of a cooler-than-expected 0.2% month-on-month core Consumer Price Index (CPI). Concerns persist about the potential economic damage from tariffs, and the 10-year USD swap spread remains above 50 basis points, reflecting ongoing apprehension about debt issues.

Federal Reserve rate expectations remained unchanged despite the softer CPI data, as April’s figures did not capture the full extent of tariff impacts. Market sentiment has shifted towards fewer rate cuts, with only 50 basis points priced in by year-end. The focus remains on the lower inflation risks and pessimistic views on US growth, which might affect dollar performance.

Forex Market Risks

The dollar is seen as potentially stabilising after experiencing volatility, while high-beta commodity currencies are preferred as market confidence grows following improved trade news. Risks associated with the forex market are highlighted, and readers are urged to thoroughly research before engaging in trades due to possible losses, emphasising the importance of caution in foreign exchange investments.

The recent pullback in the US dollar, nearly nullifying all the short-term gains it made, can be linked to trade developments pointing toward a thaw in tensions with China. More precisely, the currency cooled off at the same time the latest inflation figures—specifically, the core CPI—came in a touch lower than anticipated, rising just 0.2% for the month. That muted figure, while seemingly benign on the surface, played its part in halting the dollar’s advance. But it’s not only about inflation numbers or trade headlines. A deeper look shows the 10-year USD swap spread still elevated above 50 basis points. That level is far from ordinary and has consistently conveyed financial system stress or lingering nervousness around the public debt debate.

We noticed that traders—while initially expecting more aggressive easing—are dialling back expectations. The market is now pricing in only a total of two cuts of 25 basis points each before year-end. This adjustment suggests a rising reluctance to believe the Fed will step in with decisive action anytime soon. The cooling CPI data didn’t really sway that view; investors are most likely waiting for more consistent disinflation before adjusting their positions again, particularly since the full economic weight of tariff measures has yet to manifest in the standard data sets. Powell’s commentary and the data for later months will become more telling.

Attention on Inflation Expectations
With policymakers holding firm and inflation still sticky in places, the dollar’s bounce-back has – for now – paused. It hasn’t completely reversed direction but instead settled into a level that might tempt range-bound behaviour. In this period of relative dollar softness, what stands out is the preference for currencies closely tied to global growth. Among those, commodity-linked options have drawn attention, especially as optimism rises after early signs of friction easing on trade.

However, any trade decisions should remain firmly rooted in the underlying fundamentals and the potential for market disruptions. The dollar may look less aggressive, but that doesn’t automatically hand success to currencies like the Aussie or the Loonie. Short-term rallies can flip, particularly if another risk flare-up occurs or inflation data wakes the Federal Reserve from its current stance.

It’s also worth paying attention to how well inflation expectations match reality over the next few months. Deviations between expected and actual figures have had outsized effects on rate bets and cross-asset moves recently. Most of us have experienced how quickly a change in tone from just one central banker or a shift in headline risk can send implied volatility higher again.

So, what we’re doing is keeping our strategies nimble, staying well aware of how far forward rates pricing has moved, and watching the belly of the curve for pace-setting signals. For now, high-volatility expressions based on a single inflation print or one trade headline seem overly reactive. Short-dated options offer better cost controls and flexibility for directional plays, but only if entered with clear risk parameters.

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