A U.S. dollar bounce in reaction to imminent reciprocal tariff announcements might be the perfect moment to cash out before deeper economic tensions unravel the greenback, according to Bank of America.

In its latest FX Viewpoint report, the team led by Athanasios Vamvakidis reaffirmed a bearish outlook for the dollar beyond the near term, citing diverging policy paths between the U.S. and Europe.

While the dollar may gain ground following the tariff rollout, Bank of America said the rally would likely be short-lived as stagflation risks mount in the U.S. and Europe accelerates its fiscal and structural stimulus.

“Most likely, this would be a USD rally to sell,” the note stated.

At the time of this writing, the Invesco DB USD Index Bullish Fund ETF UUP is down 3% year-to-date, while the Invesco CurrencyShares Euro Currency Trust FXE has gained 4.5% over the same period.

Dollar Set To Gain On Tariffs, Yet Fundamentals Remain Shaky

“The USD could still strengthen short-term on high tariffs, but we remain bullish EURUSD for the year on stagflationary U.S. policies and historic EU reforms,” Vamvakidis said.

Historically, the U.S. dollar's response to tariffs has been mixed.

While trade barriers can curb imports and boost inflation — supporting the dollar short term — they also threaten growth and trigger risk aversion, which can weigh on the currency over time.

Ahead of the April 2 tariff implementation, Bank of America observed that hedge funds resumed dollar buying after unwinding stretched long positions earlier this year.

According to analysts, the overall USD market position is now neutral.

How Could The Fed Respond To Stagflation

Bank of America maintains a bearish medium-term view on the greenback, driven by what it sees as a stagflationary U.S. policy mix: high tariffs, fiscal tightening and unclear monetary direction from the Federal Reserve.

The market has already priced in four rate cuts this year, up from just 1.5 cuts at the start of 2025. That shift stems from expectations that the Fed will prioritize economic support over reacting to temporary inflation spikes caused by tariffs.

"If the Fed hikes in response to inflation, we would expect the USD to strengthen again," Vamvakidis said.

Yet, he warned that such strength could be short-lived, as tighter policy may eventually lead to a sharp equity sell-off and economic contraction — bringing the dollar back down.

Bank of America's FX desk says government spending cuts and higher tariffs are defining the policy backdrop, dragging the U.S. closer to stagnating growth combined with elevated inflation.

Europe's Comeback: Can The Euro Overtake?

While the U.S. faces policy uncertainty, Europe is quietly orchestrating its most ambitious economic transformation in over a decade.

Vamvakidis said the European Union’s push to spend 800 billion euros on defense and invest in infrastructure is a historic pivot, especially for Germany, which is executing a 12-year fiscal expansion worth at least 22% of GDP.

The fiscal shift marks a break from years of austerity.

"These are game changers," Bank of America said, adding that the market is underestimating the long-term impact of the EU’s reform agenda. However, it also warned that the shift would take time to fully materialize. "It is going to be a marathon, not a sprint."

The bank sees the euro-dollar exchange rate rallying to 1.15 levels by December 2025, up nearly 7% from current levels.

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