• The dollar outlook has deteriorated after the Fed left rates unchanged and provided little clarity on its policy path, according to MUFG.
  • Rising inflation expectations and fading confidence in the Fed could steepen the yield curve, a pattern that has historically weighed on the U.S. dollar.
  • Markets are now data-dependent, with the dollar vulnerable to swings based on inflation and labor data.

MUFG warned that the dollar's prospects have dimmed following the Federal Reserve's decision to hold interest rates steady and its failure to offer clear guidance on future policy moves. The bank's research flags rising inflation expectations and eroding trust in the Fed as factors that could steepen the yield curve, with long-term yields rising faster than short-term rates. Historically, such a pattern has been a headwind for the greenback.

"The Fed's lack of clarity is fueling uncertainty, and if inflation expectations stay elevated, the dollar could face sustained pressure," a MUFG strategist said. The bank noted that markets are now heavily reliant on incoming data, with attention focused on inflation, wage growth, and the Fed's communication style. A delay in rate cuts or a shift to a more data-dependent stance could keep volatility elevated in currency and fixed-income markets.

The warning comes as the Fed's policy path remains opaque, with Chair Jerome Powell emphasizing a wait-and-see approach. Some analysts argue that if disinflation accelerates and the Fed signals a clearer easing path, the dollar could weaken. Conversely, persistent inflation might keep the dollar supported in the near term. MUFG's analysis suggests that market pricing may overestimate the speed of Fed easing, leaving the dollar susceptible to shifts in inflation momentum. The yen and euro, meanwhile, are watching these dynamics closely, as policy divergence with other major central banks will shape relative yields and currency strength.

Correction: A previous version of this article mischaracterized MUFG's forecast horizon. The bank's warning focuses on near-term risks rather than a long-term trend.