US Dollar Defies Structural Headwinds on Cyclical Strength

The US dollar has faced mounting pressure from structural headwinds in recent years, including an overvalued real exchange rate and persistent fiscal and trade deficits.

However, despite these challenges, the dollar remains resilient against most major currencies.

This resilience can be attributed to cyclical factors, which have helped offset longer-term structural pressures. Interest rate differentials have traditionally been a key driver of currency movements, influencing global capital flows and portfolio allocation.

Recent shifts in US Federal Reserve policy have reinforced the role of interest rate differentials in supporting the dollar.

The Fed initially expected to reduce interest rates by 50 basis points in 2026, but has since shifted towards a more hawkish stance under Chair Kevin Warsh, leading to higher expectations for policy rates.

This means US policy rates will remain well above those in other major advanced economies, such as the ECB's deposit facility rate and the Bank of Japan's policy rate.