USD: How Crippling Tariff Uncertainty Keeps the Dollar on Edge – Commerzbank Analysis

FRANKFURT, March 2025 – The US dollar finds itself in a familiar yet precarious position, buffeted by waves of policy speculation rather than concrete economic data. According to a recent analysis from Commerzbank, persistent uncertainty surrounding future US tariff policy continues to act as a significant anchor on the greenback’s momentum, injecting volatility into global currency markets. This analysis delves into the mechanics of this relationship, exploring historical precedents and the specific channels through which trade policy ambiguity translates into currency market stress.

USD Stability Undermined by Tariff Uncertainty

Currency traders and institutional investors typically price assets based on a balance of measurable fundamentals: interest rate differentials, growth projections, and inflation data. However, the specter of unpredictable trade policy introduces a powerful, non-quantifiable variable. Commerzbank’s foreign exchange strategists note that markets despise uncertainty more than they fear bad news. Consequently, when the direction of US trade policy—particularly regarding tariffs on key partners like the European Union and China—becomes opaque, the dollar often reacts with heightened sensitivity. This environment prevents the currency from finding a stable footing, regardless of otherwise supportive factors like relative economic strength.

Historically, periods of pronounced trade tension have correlated with increased dollar volatility. For instance, the market turbulence during the 2018-2019 US-China trade war serves as a critical reference point. During that episode, the DXY (US Dollar Index) experienced sharp, policy-driven swings that often disconnected from underlying macroeconomic trends. Analysts observe a similar pattern emerging, where headlines and political rhetoric regarding potential tariff escalations or reductions cause immediate, sometimes exaggerated, movements in forex pairs. This behavior underscores the market’s current hypersensitivity to trade-related news flow.

The Direct Impact of Trade Policy on Currency Markets

Trade policy uncertainty affects the US dollar through several interconnected channels. Firstly, it directly influences expectations for global trade flows and economic growth. Potential tariffs threaten to disrupt supply chains, raise costs for businesses, and dampen international commerce. Since the US dollar serves as the world’s primary reserve and transaction currency, any threat to global trade volume can impact demand for dollars, creating a headwind for its value.

Secondly, this uncertainty complicates the Federal Reserve’s policy calculus. The central bank must weigh the inflationary impact of tariffs against their potential to slow economic activity. This dual effect makes future interest rate paths less predictable. As interest rates are a primary driver of currency valuation, this policy fog diminishes the dollar’s appeal to yield-seeking investors. Furthermore, tariffs can trigger retaliatory measures from trading partners, potentially leading to a broader slowdown that hurts US export sectors and, by extension, corporate earnings—a key consideration for foreign investors holding US assets.

Commerzbank’s Expert Analysis and Market Positioning

Commerzbank’s research team emphasizes that the current market narrative is not about tariffs themselves, but about their unpredictability. “Markets can price in a known tariff,” a senior Commerzbank FX strategist explained in a client note. “What they cannot price is the risk of an unknown tariff announced via social media or political speech with unclear implementation details.” This environment forces risk managers to increase hedging activities, which itself can amplify currency swings. The bank’s data shows options markets pricing in higher volatility for dollar crosses, particularly against currencies of major US trade partners, reflecting the cost of insuring against sudden, policy-driven moves.

The analysis also points to shifting capital flows. Some investors may seek temporary haven in other reserve currencies like the Swiss franc or the Japanese yen during spikes in trade rhetoric, despite the dollar’s traditional safe-haven role. This fractional diversification away from the dollar during periods of US-centric policy uncertainty further contributes to its unstable performance. The table below summarizes the primary transmission channels:

Historical Context and the Path Forward

Understanding the current juncture requires a look back. The post-2016 era fundamentally altered the market’s perception of US trade policy, moving it from a largely predictable, rules-based framework to a more fluid and politically-driven tool. This shift means that every administration change or electoral cycle now carries heightened currency risk related to trade. Commerzbank’s report suggests that for the dollar to stabilize and reflect its underlying economic fundamentals more clearly, the market needs either clarity on the tariff trajectory or a decisive shift in focus toward other dominant drivers like monetary policy divergence.

In the near term, currency traders are advised to monitor several key indicators beyond headline trade news. These include:

• Business Investment Surveys: Forward-looking capital expenditure plans can signal corporate confidence in trade stability.
• Supply Chain Pressure Indices: Rising pressures may foreshadow trade disruptions that impact currency flows.
• Federal Reserve Communications: Any mention of trade policy in Fed minutes as a risk factor is highly significant.

Ultimately, the dollar’s performance will remain bifurcated—potentially strong on domestic data but vulnerable to sudden shifts in the international trade policy landscape until a more predictable framework emerges.

Conclusion

In conclusion, Commerzbank’s analysis highlights that tariff uncertainty remains a powerful and persistent drag on the US dollar’s stability. While the US economy may exhibit strength in isolation, the currency’s role as a global benchmark makes it susceptible to the vagaries of international trade policy. The lack of a predictable, long-term US trade strategy injects volatility that distorts typical fundamental analysis, keeping the dollar on edge. For markets to confidently price the USD, reducing this policy fog is as crucial as any economic dataset.

FAQs

Q1: Why does trade policy uncertainty specifically hurt the US dollar?
Trade policy uncertainty hurts the USD because it threatens the global trade system in which the dollar is the primary transaction currency. It also clouds the economic outlook and complicates Federal Reserve policy, making the dollar less attractive to investors seeking predictable returns.

Q2: Has this happened before with the US dollar?
Yes, similar periods of elevated volatility occurred during the US-China trade war initiated in 2018. The dollar experienced sharp, news-driven swings that often ran counter to interest rate expectations, demonstrating how trade rhetoric can decouple currency from fundamentals.

Q3: What would resolve this uncertainty for currency markets?
Markets would benefit from either a clear, long-term US trade policy framework with predictable rules or a decisive shift in market focus toward other dominant drivers where the US holds a strong comparative advantage, such as technology or energy exports.

Q4: Do tariffs always weaken a country’s currency?
Not necessarily. If tariffs are seen as improving a trade balance by reducing imports, they could theoretically strengthen a currency. However, the uncertainty surrounding their implementation and the high risk of retaliation and reduced global trade often create a net negative effect, as seen currently with the USD.

Q5: How are traders and institutions responding to this environment?
Many are increasing their hedging activities using options and futures to protect against sudden swings. Some are also temporarily diversifying into other reserve currencies during peaks of trade tension and paying closer attention to forward-looking surveys about business investment and supply chain health.