US dollar post worst year since 2017 as Fed turmoil, tariffs bite hammered currency

• April tariff blitz proved the turning point, with Trump imposing 10% baseline duties that sent the S&P 500 down 13% in a week and triggered the dollar's steepest six-month decline in over half a century
• China reduced Treasury holdings to 2008 lows while global asset managers increased hedges against dollar weakness, with core inflation hovering near 3% limiting Fed flexibility
• Markets anticipate additional Fed rate cuts in 2026 as Kevin Hassett emerges as frontrunner to replace Jerome Powell in May, further undermining the dollar's yield advantage

The US dollar posted its worst annual performance since 2017, declining approximately 8% against a basket of foreign currencies in 2025. Some measures showed losses approaching 9-10%, with the first half experiencing the steepest six-month decline in over half a century.

President Trump's April 2 "Liberation Day" tariffs served as the primary catalyst, implementing a 10% baseline tariff on nearly all imports with higher "reciprocal" duties for countries with US trade surpluses. The announcement triggered immediate market turmoil, sending the S&P 500 down over 13% in less than a week.

Key factors undermining the dollar included:

• Persistent core inflation near 3%, limiting Federal Reserve flexibility
• China reducing Treasury holdings to lowest levels since 2008
• Global asset managers increasing hedges against dollar weakness
• Rising inflation expectations due to tariff pressures

The Federal Reserve shifted to an accommodative stance, cutting rates by 0.25% in both September and December as unemployment rose and payroll growth slowed. Markets currently price in 1-4 additional rate cuts for 2026.

Leadership uncertainty adds further pressure, with Jerome Powell's term ending in May. Kevin Hassett, director of the National Economic Council, is considered the frontrunner for Fed Chair, though questions remain about maintaining central bank independence.

Treasury yields declined from above 4.5% early in the year to approximately 4.1% by December, eroding the dollar's yield advantage. Foreign exchange strategist Yusuke Miyairi of Nomura identified Fed policy as the critical factor for Q1 2026, emphasizing the importance of January and March meetings alongside the leadership transition.