St. Louis Federal Reserve President Alberto Musalem anticipates lower economic growth this year than the trend. He noted that tariffs could raise inflation risks and potentially dampen economic activity as companies adjust supply chains and consumers face increased prices.
Musalem indicated that tighter financial conditions over a few months could impact economic performance. He emphasised that inflation expectations must remain anchored, and if they diverge, combating inflation would take precedence.
Following these comments, the US Dollar struggled, with the US Dollar Index declining by approximately 1% to 99.92.
Economic Output Concerns
What Musalem essentially highlighted is a concern that economic output may fall short of its long-term average this year, partly due to existing pressures in trade and finance. Tariffs, as he put it, can increase costs for businesses and consumers alike, making everyday goods more expensive while companies reconfigure logistics and sourcing. That adjustment is not seamless and tends to weigh on activity over time.
He also pointed to financial conditions tightening — meaning credit is harder to access, and borrowing becomes more expensive. Over a period of months, this stiffness could bite into demand and slow business investment. If borrowing costs remain high or banks become more risk-averse, this could suppress spending and investment further.
Another point he made, somewhat firmly, is around inflation expectations. There is little room for slippage. If market or consumer expectations begin to drift from the Federal Reserve’s 2% inflation target, the policy response would need to be swift and likely aggressive. In essence, if expectations become unmoored, there would be no choice but to take tougher action to restore credibility.
Dollar Weakness and Market Implications
Shortly after those remarks, we saw the US Dollar lose strength. The Dollar Index, a measure of the greenback’s strength against a basket of major currencies, slipped around 1%, dropping below the 100 threshold. Markets appeared to price in softer economic prospects and perhaps a reduced path for rate hikes or earlier cuts, though direction there remains data-dependent. This decline in defensive demand for the US Dollar illustrates how quickly sentiment adjusts when forward-looking growth and policy appear less supportive.
This movement in the currency brings volatility to rates and FX-linked derivatives. Traders positioned around potential rate differentials now face a fresh recalibration as data and forward guidance pull against earlier assumptions. We might examine hedging strategies that were optimised for a persistently strong dollar and consider whether they now require unwinding or rotation. Short-term volatility on options pricing, particularly in rate-sensitive instruments, may expand in either direction, especially if contradictory economic signals materialise through upcoming payroll or CPI reports.
The shift suggests rate expectations could become more conditional and less anchored to a specific terminal projection. From our standpoint, this prompts a closer look at tenor spreads and the implied vol surfaces. Moves like this — where commentary triggers a sharp reaction — call for marked attention to correlation shifts across asset classes. Dollar weakness, if it persists, has implications far beyond the currency itself. It affects multinational earnings expectations, commodity import costs, and cross-border fund flows.
We’re likely entering a phase where macro traders will prioritise flexibility in positioning, particularly around key economic prints. Watching breakeven inflation levels and short-term yield curves becomes more relevant, as these offer signals about whether inflation expectations still align with the Fed’s target trajectory. As long as confidence in inflation control remains intact, pricing may stay relatively orderly — but the risk premium for that assumption is not zero.
