For a currency that typically strengthens during global uncertainty, this weakness felt unusual. But storms do not last forever. And now, the very concerns that dragged the dollar lower may slowly be turning into reasons for a rebound.
Why the Dollar Was Struggling
The dollar’s weakness was not random; it was built on a series of concerns.
First, markets became convinced that the Federal Reserve would begin cutting interest rates aggressively. Rate cuts typically weaken a currency because lower yields reduce its appeal. Expectations of an economic slowdown added further weight to that view.
Second, there were deeper concerns about the Fed’s independence. Markets fear one thing above all: monetary policy influenced by politics. Any hint of political pressure can weaken confidence in a currency.
Then there was uncertainty surrounding Donald Trump’s trade and fiscal policies. Tariff headlines, budget debates, and shifting policy signals made investors cautious.
The dollar was not collapsing but it was gradually losing confidence.
What Has Changed?
1. The Data Tells a Different Story
Here’s where the narrative shifts.
The expectation of rate cuts was built on fears of economic weakness. But the U.S. economy has not behaved like a weak economy.
• Growth projections for 2026 have been revised upward. The International Monetary Fund now sees U.S. real GDP expanding around 2.4%, while the Fed projects about 2.3%. That’s not recession territory, that’s steady expansion.
• Labour markets are holding firm. The U.S. added 130,000 jobs recently, and unemployment has eased to 4.3%. The four-week average of ADP employment change improved from 7.8K to 10.3K.
• Business activity supports that view. The S&P Global US Composite PMI rose to 53.0 in January 2026, above both the preliminary estimate and December’s level. Manufacturing and services are expanding.
It is like expecting rain all week and then waking up to sunshine. Slowly, people put their umbrellas away.
2. The Fed Independence Question: A Calmer Tone
Another big overhang was the fear that the Fed’s independence could weaken.
The nomination of Kevin Warsh to lead the Federal Reserve has helped calm those worries. He is seen as disciplined and unlikely to flood markets with easy money or compromise the Fed’s credibility.
In fact, his focus on balance sheet reduction, continuing quantitative tightening, signals tighter liquidity ahead. That means fewer dollars in the system, firmer financial conditions, and a supportive backdrop for the currency.
Because in the end, dollar strength is not just about growth or rates, it is also about trust and policy discipline.
3. Tariff Fears vs. Economic Reality
Tariffs were initially feared as inflationary and growth-negative, with concerns that higher import costs would hurt jobs and economic momentum. However, these risks have largely not materialised. Inflation remains well controlled, growth has held up, and the labour market has not seen any meaningful deterioration.
At the same time, tariff revenues have surged. The federal government collected $195 billion in customs duties in FY 2025, over 250% higher than FY 2024, reflecting the impact of tariff policies under President Donald Trump.
With inflation contained and fiscal revenues rising, tariffs are increasingly viewed as dollar-supportive rather than destabilising.
One Factor Never Truly Disappears: Geopolitics
Tensions between the U.S. and Iran have once again reminded markets why the dollar remains the world’s preferred safe haven. When uncertainty rises, capital looks for depth, liquidity, and safety.
And no market offers that combination quite like U.S. Treasuries.
Additionally, reports suggest that Russia is actively considering a return to the U.S. dollar settlement system as part of broader economic discussions with Washington. If such a move materialises, it would quietly reinforce the dollar’s dominance in global trade, especially in energy markets.
In times of stress, investors still run towards the dollar, not away from it.
DXY Outlook: With Weak UK and Even Weaker Euro
The backdrop for the dollar is quietly improving, not just domestically, but externally as well. The euro and the pound together account for nearly 70% of the U.S. Dollar Index, and both economies are currently facing structural growth challenges and softer momentum. With Europe and the UK underperforming, the relative equation naturally begins to favour the dollar.
The dollar’s recent weakness was driven by fears of economic slowdown, rapid rate cuts, policy uncertainty, and doubts over Fed independence.
Today, those concerns appear less threatening. U.S. growth remains steady, labour markets are resilient, and expectations for aggressive rate cuts are being pushed further out. Trade tensions have stabilised, while geopolitics continues to underpin safe-haven demand.
Against this backdrop, both technically and fundamentally, the U.S. Dollar Index appears positioned for a rebound towards the 100.00 to 100.50 zone in the coming months, with scope for a broader extension towards 102 if momentum sustains.
The dollar may not return to runaway strength, but the narrative of persistent decline is clearly fading. Sometimes a currency does not need perfect conditions to rally, it simply needs uncertainty to ease. And that shift may already be underway.
Outlook for Rupee
If the dollar is preparing for a comeback, the rupee cannot remain untouched. The relationship is simple but powerful: when the dollar strengthens globally, emerging market currencies, including the Indian rupee, tend to feel the pressure.
But the rupee story is not only about the dollar. Domestic dynamics are adding their own layers.
• India’s defence commitments are rising meaningfully. Large approvals, including purchases of Dassault Aviation’s Rafale jets, alongside a historic Rs 7.85 lakh crore ($93.5 billion) allocation to the Ministry of Defence in the Union Budget 2026–27 (a 15.19% increase from last year), imply sizeable future dollar outflows. Defence imports translate into structural dollar demand, steady, recurring, and difficult to compress.
• At the same time, India’s merchandise trade deficit widened sharply to $34.68 billion in January 2026, well above expectations. A wider deficit means more dollars leaving the system to pay for imports. If crude oil prices trend higher, that pressure could intensify further, expanding the import bill and reinforcing dollar demand.
• While India’s forex reserves remain comfortable at $717.06 billion, with $570.05 billion in foreign currency assets, the cushion is not absolute. The Reserve Bank of India carries a net short forward position of roughly $66 billion, effectively committed future dollar sales that will eventually need to be bought back.
The implication is subtle but important: even if strong inflows emerge, the RBI may absorb them to rebuild forward positions, limiting sharp rupee appreciation.
Technically, the 90.50 to 90.80 zone in USD/INR is expected to act as strong support. However, with global dollar strength attempting a rebound and domestic dollar demand building structurally, the pair is likely to move towards 92.00 in the near term.
(The author Amit Pabari is MD, CR Forex Advisors)
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