(Bloomberg) — The dollar retreated in August after posting its best month this year as investors prepare for a weaker US economy and interest-rate cuts even as inflation continues to advance.

The Bloomberg Dollar Spot Index lost 1.7% this month, trimming its 2.7% advance in July, which was its first month of gains since President Donald Trump was sworn into office. 

Wall Street expects the world’s reserve currency to extend its 8% decline this year as the economy shows some signs of slowing and the Federal Reserve looks set to start cutting rates again. On top of that backdrop, Trump is questioning the credibility of the central bank as well as the validity of economic data, further undermining the greenback’s appeal. 

“There are long-term implications from the US administration’s recent actions,” Jayati Bharadwaj, head of FX strategy at TD Securities, said in a Wednesday note. “This chips away at the USD’s safe haven status and risk premia should start to weigh it down.”

Concerns over central bank independence have dented the dollar’s appeal. Trump moved earlier this week to oust Fed Governor Lisa Cook, who has vowed to stay on and fight. Cook sued the president Thursday kicking off what will likely be a lengthy process, starting with a hearing Friday.

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There’s a “real risk” that multiple Fed district bank presidents get removed from office next year due to politically charged maneuvering from the White House, warned Lael Brainard, a former Fed vice chair.

On Friday, the Bloomberg Dollar Spot Index was little changed after the so-called core personal consumption expenditures price index, which excludes food and energy items and is favored by the Federal Reserve, matched month-on-month estimates, rising 0.3% in July from the previous month. Late in the session, short-term yields moved lower after the Fed’s San Francisco President Mary Daly signaled openness to cutting rates in September.

“If Trump resets relations with the Fed, that resembles emerging-market dynamics we’ve seen elsewhere and they are hardly bullish for the currency,” said Sahil Mahtani, director at Ninety One Asset Management’s Investment Institute in London.

Technical analysis also points to a clear downtrend for the US currency. Traders now expect a slight decline of the greenback over the next three- to six-month horizon, options pricing as of Friday shows. The dollar gauge fell below its 100-day moving average in early March and has stayed there ever since. Two attempted breakouts failed this month, leaving the moving average a major resistance. 

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Meanwhile, non-commercial traders — a group of speculative market players that includes hedge funds, asset managers and others — reduced their short dollar bets to some $5.6 billion in the week through Aug. 26, according to the latest Commodity Futures Trading Commission data aggregated by Bloomberg.

‘Less Attractive’

Fed Chair Jerome Powell signaled in his keynote speech at the Jackson Hole symposium readiness for a rate reduction as soon as its next policy meeting on Sept. 17. 

As of Friday, interest-rate swaps show an 80% chance the Fed cuts rates in September, and fully price a total of two quarter-point reductions through the end of 2025. In total, 125 basis points of easing are priced through September 2026.

The heightened projection for cuts is sending Treasury yields lower. And that “alongside slightly higher inflation makes a currency less attractive,” said Mahtani.

Expectations for extended dollar weakness will likely prompt international investors to increase their FX hedging of US holdings. The dollar hedge ratios for Danish pension funds and insurers have climbed since the beginning of this year and stayed flat between May and June, according to Morgan Stanley, though latest details for most other European countries as well as Japan and Australia are still unavailable. 

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“We are constructive on US assets, but not the US currency,” said Serena Tang, global head of cross-asset strategy research at Morgan Stanley in New York. “US financial markets are still unmatched in size and liquidity. This said, rising policy uncertainty will likely drive foreign investors to up their FX-hedging ratios, putting pressure on the dollar.”   

Foreign investors hold $32 trillion in dollar assets overall, according to Ninety One’s Mahtani, who estimates about $1 trillion of potential dollar selling if hedge ratios normalize.

“My sense is the bulk of the hedge adjustment is still ahead,” Mahtani added.

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