The Dollar Bounces Back in July. Where It Goes From Here.

The dollar is on pace for the best July since 2019. (Dimas Ardian/Bloomberg)

The dollar is breaking out of a pattern: It is on pace for its first up month since December.

The U.S. dollar index is up 2.1% this month. If it keeps pace, it will also mark its best July since 2019, when it closed the month up 2.48%. The shift in sentiment comes after the dollar declined broadly against all major currencies in the first half of 2025.

The downtrend was expected to last. Expectations of Federal Reserve rate cuts, prospects of a weakening U.S. labor market, and foreign investors hedging their vast amounts of dollar assets were all factors that kept Wall Street pessimistic and preparing for the euro to rise toward $1.20 by year-end against the dollar, a level not seen since 2021.

Why the Dollar Rallied

Perceived U.S. advantage in the trade deal with Europe has powered some of the dollar’s gain this month.

“The deal avoids the worst-case scenario and prevents trade war escalation, but the initial FX response suggests the terms are seen as asymmetric and unbalanced…turning sentiment sharply negative on the euro,” wrote Société Générale’s FX Strategist Olivier Korber.

That likely led to “position squeeze.” In plain English, traders who had bet on the euro rising and dollar falling were forced to rapidly close out their losing bets, accelerating the decline.

Positive optics are also boosting the dollar more broadly. Though many countries like Canada and Mexico hang in balance, U.S. has agreed to trade deals with Japan, Indonesia and Philippines before the Aug. 1 deadline, alleviating concerns that the U.S. is divorcing its allies.

“The recent US re-engagement with the rest of the world nullifies the reasons for the USD selloff in March to June—i.e., that the USD was no longer worthy of its reserve currency status in an increasingly multipolar, leaderless world, with deglobalization.” wrote Macquarie strategist Thierry Wizman.

Where Currencies Go From Here

The euro settled at 1.1547 U.S. dollars on Tuesday, a close that is below the 55-day moving average of 1.1568. When an asset price or yield crosses below its moving average, it is a technical indication that the downtrend will likely continue. A weaker euro will mean a stronger dollar, in this case.

Yet, many Wall Street’s FX strategists are holding on to their views of a weaker dollar in the second half.

“The impulse to diversify away from the US will remain robust this year, we believe, leading to modest further gains for the EUR, CAD, and JPY vs. the USD,” Wizman wrote, adding that the dollar and dollar-denominated assets looks overvalued to him. Citi’s FX Strategist Daniel Tobon sees a weaker labor market report pushing the dollar lower this year.

Moreover, the perception of policy uncertainty in the U.S. remains. The current White House administration has flip-flopped on matters of “national emergency.” It has paused immigration raids and removed tariffs at times.

Weakening of the world’s reserve currency doesn’t happen in a vacuum. Central banks aren’t all on the same page. The Fed is facing inflationary pressures from a weaker dollar as it makes imports more expensive. In contrast, “disinflation is becoming a solid baseline for the rest of the world,” wrote Barclays’ FX Strategist Skylar Montgomery Koning.

Write to Karishma Vanjani at karishma.vanjani@dowjones.com.