The US Dollar recovered from three-year lows on Monday but stayed under the 97.00 mark. Trade deal advancements, particularly between the US and China, and potential tariff talks with Canada, influence its performance.
Canada agreed to end its digital tax, leading to resumed trade discussions with the US. Behind-the-scenes negotiations with the EU and Japan hint at possible trade normalisation, affecting the Dollar’s appeal.
United States Tax Legislation
Trump’s tax legislation, designed to reduce taxes while increasing US debt, has progressed in the Senate. Concerns about US debt might hinder the Dollar’s short-term recovery.
The US Dollar is the official currency of the US and circulates globally, trading massively. It replaced the British Pound as the reserve currency post-WWII and was once gold-backed until 1971.
Federal Reserve’s monetary policy impacts the US Dollar. The Fed influences Dollar value by adjusting interest rates to manage inflation and employment, raising rates to strengthen it.
In crises, the Federal Reserve uses quantitative easing by increasing Dollar supply and buying government bonds, which weakens the Dollar. Conversely, quantitative tightening strengthens the Dollar when the Federal Reserve reduces bond buying and stops reinvestments.
Global Trade Developments
Markets had a brief look at strength returning to the Dollar at the start of the week, though relief faded near the 97.00 barrier. However, this does not necessarily signal a broader turn. Much of the movement stems from renewed optimism surrounding ongoing trade developments. With Canada’s decision to walk back its digital tax, Washington has returned to the discussion table — an action generally seen as reducing friction and, for now, restoring confidence between the two countries.
Behind closed doors, conversations with Tokyo and Brussels are advancing slowly. While headlines have remained tame, sources have suggested that easing trade disagreements with both could be enough to support a mild recovery in USD demand — provided that results, not speculation, come through.
Those tracking derivative pricing closely should be patient and especially alert to yield differentials and forward guidance. While spot prices reacted quickly to political movement, options traders may benefit from taking direction from legislative progress. For example, the tax reform package, which is moving through the Senate, introduces long-term questions about U.S. debt sustainability. Notably, Trump’s policy of slashing taxes while expanding the fiscal deficit is being pushed forward with fewer revisions than expected, creating hesitation among some foreign investors.
That hesitation is not just rooted in policy mechanics. An expanding federal deficit typically increases net issuance of government securities, which can mute Dollar demand through concerns regarding repayment or inflation expectations later on. For rate-sensitive instruments, it highlights disconnection between nominal rates moving higher and real returns, which may be capped if inflation expectations scale up in parallel.
Federal Reserve policy remains the foundation for Dollar strength in most macro models. They typically raise borrowing costs to curb inflation or stimulate the currency, particularly when risks of overheating surface. Yet what is less often priced into short-term contracts is the Fed’s balance sheet management, which is sometimes overlooked despite its substantial impact. These tools, such as reinvestment tapering or selective bond selling, are currently being used to fine-tune liquidity but have not yet reversed course.
Since the financial meltdown in 2008, it has been easy to forget how much liquidity the Fed injected through quantitative easing programmes — not just in distress moments, but for audience expectations management. When the central bank steps back from those commitments, we tend to see stronger Dollar waves, as low-risk returns in treasuries climb, attracting flows. Recent noises from policymakers suggest that any pause in balance sheet tightening would be tied to growth data, which for now remains uneven.
Because Dollar pricing is so tightly linked to perceptions of U.S. creditworthiness, anything that raises lending costs without corresponding growth — such as rising debt with fewer tax receipts — could counteract rate hikes. Therefore, we think it makes sense to remain cautious on aggressive USD-long positions unless paired with hedges in correlated assets, such as high-yield corporates or selected emerging market currencies.
In short-term setups, the Dollar will likely continue to move within a narrow band, influenced less by raw interest rate levels and more by perceived credibility of policy execution. As always, liquidity in FX derivatives provides opportunities when price ranges tighten and implied volatility misaligns with realised data. This window may remain open if fiscal risk continues to offset rate optimism.
