Dollar Weakens as Investors Reprice US Policy Risk

The US dollar is heading for its weakest week since June 2025, as political uncertainty in Washington outweighs strong economic data and rising Treasury yields.

The Bloomberg Dollar Spot Index fell to a three-week low and is down around 0.8% over the past five sessions. The move comes ahead of next week’s Federal Reserve meeting, where markets see almost no chance of an immediate rate change.

What stands out this time is why the dollar is falling. US Treasury yields have moved higher on expectations that the economy remains resilient and the Fed will stay on hold. Normally, that would support the currency. Instead, the dollar is weakening.

FX markets are increasingly focused on political risk.

Earlier this week, investors were whipsawed by US President Donald Trump’s tariff threats toward Europe linked to negotiations over Greenland. The rhetoric briefly escalated tensions with key NATO allies before being abruptly rolled back following talks with NATO Secretary General Mark Rutte at the World Economic Forum in Davos.

This sudden shift in policy direction has unsettled currency markets. Options traders are now paying a premium to hedge against further dollar losses over the next month — a sharp reversal from just a week ago, when bullish positioning on the greenback was at its highest level since November.

Despite solid labour market data — with US initial jobless claims remaining near historic lows — analysts say economic strength is no longer enough to shield the dollar.

“The fact that the dollar is sliding even as yields rise tells you politics matter more than monetary policy right now,” FX strategists note.

Markets are currently pricing in two quarter-point rate cuts later this year, while volatility around the January 28 Fed decision has climbed to its highest level in more than a month.

Adding to uncertainty, President Trump said he has completed interviews for the next Federal Reserve chair and reiterated that he already has a candidate in mind — a reminder that institutional independence may once again become a market issue.

Against this backdrop, discussion is growing about large investors reducing exposure to dollar-denominated assets, particularly amid renewed strains in US–Europe relations.

For now, the message from FX markets is clear: political risk has returned as a key driver for the dollar, and analysts are increasingly cautious on the greenback in the weeks ahead.