Synopsis:

BofA acknowledges that first-round effects of tariffs have supported the USD, but argues that a full-blown global trade war, with widespread retaliation against the US, could ultimately weaken the dollar. While the US economy is less trade-dependent than many others, it would still be more vulnerable in a scenario where it faces tariffs from multiple economies.

Key Points:

1. Tariff Risks Have Initially Strengthened the USD

   • The first-round effects of tariffs (higher risk aversion, widening US-EU rate differentials) have supported USD strength.
   • This aligns with economic theory, which suggests tariffs can drive safe-haven demand for the USD in the short term.

2. Second-Round Effects Could Reverse USD Gains

   • If US tariffs escalate into a full trade war with global retaliation, the dollar could weaken instead of strengthen.
   • While the US is less dependent on trade than some economies, it would be disproportionately affected if it faces collective global retaliation.

3. Key Factors That Could Weaken the USD

   • Details of US tariff policies – higher, broader tariffs could exacerbate inflation and slow growth.
   • Extent of retaliation – widespread tariffs on US exports could hurt corporate earnings and investment.
   • Risk sentiment – if confidence in US economic resilience falters, USD appeal could diminish.
   • Monetary policy response – the Fed may have to ease more aggressively if tariffs slow growth.
   • Long-term growth impact – structural damage to global supply chains could weigh on US productivity.

Conclusion:

While tariffs have initially boosted the USD, BofA warns that prolonged trade conflict could ultimately weaken the currency. If the US faces widespread retaliation and its economy slows faster than expected, the second-round effects could reverse the USD’s strength.