In the first year of "Trump 2.0," the US dollar depreciated by nearly 10%, marking the largest drop in a decade.

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In the first year of Donald Trump’s return to the White House, the US dollar is experiencing its most severe annual sell-off since 2017.

Hit by economic worries sparked by the trade war and expectations of a dovish Federal Reserve, the safe-haven status of the world’s reserve currency is facing a tough test, as markets reevaluate the dollar’s asset value in the “Trump 2.0” era.

According to data from the Financial Times, the dollar has already dropped 9.5% this year against a basket of major currencies, not only marking the largest annual decline in a decade, but also being described by Deutsche Bank’s Global Head of FX Research, George Saravelos, as one of the worst-performing years for the dollar since the advent of free-floating exchange rates. The euro has been the biggest beneficiary, surging nearly 14% against the dollar and breaking above 1.17, its highest level since 2021.

The key turning point for the dollar’s weakness began in April of this year, when Trump launched an aggressive tariff war against US trade partners. Although the dollar regained some ground afterwards, the Federal Reserve restarted its rate-cut cycle in September, keeping the dollar under prolonged pressure. Major Wall Street banks generally predict that as the Fed proceeds with rate cuts, the dollar will face further weakness next year.

Market analysts point out that compared to other major central banks, the Fed’s policy path looks particularly dovish. As investors bet the Fed will lower borrowing costs further next year, while institutions like the European Central Bank may maintain or even tighten policies, this divergence continues to weaken the dollar’s appeal—a trend that is already directly impacting FX hedging strategies and multinational corporate earnings.

Central Bank Policy Divergence Leads the Outlook for Forex Markets

With the Fed’s policy path at odds with other major central banks, interest rate differentials have become the core driver of FX volatility. Trader pricing currently suggests the Fed will cut rates by 25 basis points two to three times by the end of 2026.

In contrast, ECB President Christine Lagarde this month held rates steady while raising projections for growth and inflation, stating that “all options should remain on the table,” signaling a more hawkish stance.

James Knightley, ING’s chief international economist, notes that the Fed is “moving against the grain” among global central banks and remains clearly in easing mode.

Based on these expectations, Wall Street banks forecast that the euro/dollar rate will rise to 1.20 by the end of 2026, while the pound/dollar will climb from its current 1.33 to 1.36. While the dollar’s weakness benefits US exporters, it drags on the performance of European companies with sales revenues from the US.

Choice of Fed Chair Sparks Market Anxiety

Beyond interest rate policy itself, uncertainty about Fed leadership is also a major factor suppressing dollar valuations. Analysts warn that Trump's Fed chair nominee will determine the currency’s fate in 2026. If the successor is seen as likely to bow to White House pressure and cut rates more aggressively, the dollar may fall further.

According to the Financial Times, bond investors have already raised concerns to the US Treasury, fearing that one leading candidate, Kevin Hassett, might lower interest rates to please Trump. ING’s Knightley analyzes that under new leadership, investors are prepared for a Fed that is more interventionist, more dovish, and “more likely to act on instincts.”

Mark Sobel, US Chairman of think tank OMFIF and former Treasury official, notes that while Trump’s erosion of the dollar’s foundational dominance may be a long process, it has already cast a lingering psychological shadow over market participants.

Trade War and Hedging Strategies Reshape Capital Flows

Though the dollar has rebounded 2.5% from its annual low in September, partly because predictions of a US recession triggered by the trade war haven’t come true, and the AI investment boom is propping up US growth expectations, these trends haven’t fully reversed the dollar’s downward trajectory.

Kit Juckes, FX strategist at Société Générale, believes Trump’s economic policy cannot halt the technological revolution happening on the US West Coast, which limits how aggressively the Fed can cut rates.

Nevertheless, investor behavior has undergone structural change. Analysts point out that Trump’s chaotic policymaking—especially the market turmoil after the tariff announcement in April—has prompted foreign investors to hedge dollar exposure when buying US equities.

Deutsche Bank’s Saravelos notes that the dollar's weakness is partly driven by global investors, especially Europeans, structurally reassessing “unhedged dollar exposure.” As more investors hedge via derivatives trading, the dollar faces sustained downward pressure.

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