Why the dollar was struggling
The dollar’s weakness was not random; it was based on a series of concerns.
First, markets became convinced that the Federal Reserve would aggressively cut rates. Rate cuts tend to weaken a currency because lower yields reduce its appeal. Expectations of an economic slowdown further reinforced this view.
Second, there were deeper concerns about the Fed’s independence. The 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 about Donald Trump’s trade and budget policies. Headlines on tariffs, budget debates and changing policy signals made investors cautious.
The dollar did not collapse, but gradually lost confidence.
What has changed?
1. The data tells a different story
This is where the story shifts.
The expectation of interest rate cuts was based on the fear of economic weakness. But the US economy has not behaved like a weak economy.• Growth forecasts for 2026 have been revised upwards. The International Monetary Fund now expects US real GDP to grow by about 2.4%, while the Fed expects growth of about 2.3%. That’s not a recession area, that’s steady expansion.
• Labor markets are holding up. The US recently added 130,000 jobs and unemployment fell to 4.3%. The four-week average of employment change at ADP improved from 7.8k to 10.3k.
• Business activities support this vision. The S&P Global US Composite PMI rose to 53.0 in January 2026, above both the preliminary estimate and December levels. Production and services are expanding.
It’s like expecting rain all week and then waking up to sunshine. People are slowly putting away their umbrellas.
2. The Fed’s independence question: a calmer tone
Another major problem was the fear that the Fed’s independence could be weakened.
The appointment of Kevin Warsh to lead the Federal Reserve has helped alleviate these concerns. He is seen as disciplined and is unlikely to flood the markets with easy money or threaten the Fed’s credibility.
His focus on balance sheet reduction and continued quantitative tightening actually signals tighter liquidity ahead. That means fewer dollars in the system, firmer financial conditions and a supportive environment for the currency.
Because ultimately, dollar strength is not just about growth or interest rates, but also about confidence and policy discipline.
3. Tariff fears versus economic reality
Initially, it was feared that the tariffs would be inflationary and negative for growth, with concerns that higher import costs would hurt jobs and economic momentum. However, these risks have largely gone unrealized. Inflation remains well under control, growth has held up and the labor market has not suffered any significant deterioration.
At the same time, tariff revenues have increased enormously. The federal government collected $195 billion in tariffs in FY 2025, up more than 250% from FY 2024, reflecting the impact of tariff policies under President Donald Trump.
With inflation under control and budget revenues rising, rates are increasingly seen as supportive of the dollar rather than destabilizing.
One factor never really goes away: geopolitics
Tensions between the US and Iran have once again reminded markets why the dollar remains the world’s favorite safe haven. When uncertainty increases, capital looks for depth, liquidity and safety.
And no market offers this combination better than U.S. Treasury bonds.
Furthermore, reports suggest that Russia is actively considering a return to the US dollar settlement system as part of broader economic discussions with Washington. If such a move materializes, it would quietly strengthen 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 a weak UK and an even weaker Euro
The environment for the dollar is quietly improving, not only at home, but also abroad. The euro and the pound together account for almost 70% of the US Dollar Index, and both economies currently face structural growth challenges and weaker momentum. With Europe and Britain underperforming, the relative equation is naturally starting to tilt in the dollar’s favor.
The dollar’s recent weakness has been driven by fears of an economic slowdown, rapid rate cuts, policy uncertainty and doubts about the Fed’s independence.
Today, these concerns seem less threatening. US growth remains stable, labor markets are resilient and expectations for aggressive rate cuts are pushed further out. Trade tensions have stabilized, while geopolitics continues to support demand for safe havens.
Against this backdrop, the US Dollar Index appears positioned, both technically and fundamentally, for a recovery towards the 100.00 to 100.50 zone in the coming months, with room for a broader expansion towards 102 if momentum continues.
The dollar may not return to runaway strength, but the story of continued decline is clearly fading. Sometimes a currency doesn’t need perfect conditions to recover, it just needs uncertainty to decline. And that shift may already be happening.
Outlook for the rupee
As the dollar prepares 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 just about the dollar. The domestic dynamic adds its own layers.
• India’s defense commitments are increasing significantly. Major approvals, including the purchase of Dassault Aviation’s Rafale jets, besides a historic allocation of Rs 7.85 lakh crore ($93.5 billion) to the Defense Ministry in the Union Budget 2026-27 (up 15.19% over last year), imply significant future dollar outflows. Defense imports translate into a structural demand for dollars, which is stable, recurring and difficult to compress.
• At the same time, India’s trade deficit widened sharply to $34.68 billion in January 2026, well above expectations. A bigger deficit means more dollars leaving the system to pay for imports. If crude oil prices rise, that pressure could increase further, increasing the import bill and increasing demand for dollars.
• While India’s foreign exchange reserves remain comfortable at $717.06 billion, with $570.05 billion in foreign currency assets, the buffer is not absolute. The Reserve Bank of India has a net short forward position of roughly $66 billion, effectively locking in future dollar sales that will eventually have to be repurchased.
The implication is subtle but important: even if strong inflows arise, the RBI can absorb them to rebuild future positions, limiting the rupee’s sharp rise.
Technically, the zone of 90.50 to 90.80 in USD/INR is expected to act as strong support. With the global dollar attempting to stage a recovery and domestic demand for dollars structurally increasing, 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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