The U.S. dollar has been weakening continuously recently. On July 1, the USD Index dipped to a low of 96.37, the lowest level since late February 2022. The index slightly rebounded on July 2, yet on the next day, it once again turned bearish, dropping by 0.10% to 96.69, still below 97. In the first half of this year, the USD Index fell by a cumulative 10.8%, marking its worst half-year performance in over half a century. According to reports, the last time the dollar saw such a significant depreciation was in the first half of 1973, with a drop of 14.8%. Analysts suggest that the uncertainty surrounding the Trump administration's trade and tariff policies, Trump's pressure on the Federal Reserve to cut interest rates, and his threats to undermine the Fed's independence have all been major factors putting downward pressure on the dollar. At the same time, the high yields on long-term U.S. Treasury bonds have also been a headache for the Trump administration, as this not only dashes hopes for a Fed rate cut but also increases the cost of financing the U.S. government's budget deficit. The issues surrounding the dollar have become one of the challenging issues for Trump.

Researchers at ANBOUND have previously noted Trump's contradictory stance on the exchange rate of the U.S. dollar. On one hand, he hoped for a weaker dollar to boost U.S. exports and reduce the trade deficit; on the other hand, he did not wish to see capital outflows, which would push up market interest rates and increase the U.S. government's debt costs. This reflects the contradictions in Trump's conservative policies and the pressures and constraints in the implementation of his various policies. Unlike the Biden administration, Trump’s Make America Great Again agenda needed to address the double deficits troubling the U.S., namely the massive trade deficit and the fiscal deficit. However, the contradiction lies in the fact that, without trade deficits that allow countries to invest the dollars earned from trade surpluses, the U.S. fiscal deficit might have to rely solely on domestic investors to take on the debt. In other words, if Trump wants to achieve a trade balance, foreign governments and traders would naturally have less access to dollars, leading to capital outflows and the sale of U.S. government bonds. This would result in the U.S. government's fiscal deficit narrowing passively. To address this, Trump had previously prepared the Mar-a-Lago Accord in an attempt to help reduce the U.S. government’s debt. This agreement, planned by Trump's economic advisor, Stephen Miran, aimed to resolve the U.S. fiscal and trade double deficits by implementing a three-pronged approach: raising tariffs, currency depreciation, and offering long-term zero-coupon U.S. bonds specifically for overseas investors.

At the same time, Trump also proposed the One Big Beautiful Bill Act (OBBBA) budget, which centers on tax cuts and spending reductions. This can be considered the core policy for Trump's future administration. As pointed out by a senior researcher at ANBOUND, Trump's various policies are highly interconnected. His tariff policies not only aim to reduce the U.S. trade deficit but also increase tax revenues, which would help reduce the fiscal deficit. However, the panic and turmoil caused by his reciprocal tariffs in April created significant obstacles for the implementation of the Mar-a-Lago Accord. The market and even Trump himself have gradually realized that the uncertainty surrounding his tariff policies was posing a threat to the U.S.'s creditworthiness. While the Mar-a-Lago Accord could help the U.S. resolve its massive debt, it would inevitably threaten the dollar’s status as the world’s reserve currency. As things stand, the market feared that a debt restructuring at the expense of overseas investors' losses could destabilize the entire capital market. With the U.S. Treasury bonds being sold off and market interest rates soaring, the damage to the U.S. would actually be deeper and more extensive. This is why Trump had to suspend the execution of the reciprocal tariffs and, by extension, put the Mar-a-Lago Accord on hold. At present, it seems that the deficit and debt issues may not be solved simultaneously, forcing Trump to adopt a balancing act and seek new solutions for his increasingly large fiscal budget with a more targeted approach.

Not long ago, analysts at Deutsche Bank released a research report highlighting that the adjustments to U.S. Treasury bonds and changes in Fed regulatory policies signal a major shift in macroeconomic policy. The core goal of these changes is to reduce dependence on foreign capital and absorb the massive financing needs of the deficit through domestic resources. This policy framework was named by the Deutsche Bank the Pennsylvania Plan. The report argues that the U.S. is not simply facing a fiscal deficit issue, but a dual dilemma of both fiscal deficit and trade deficit. Capital outflows had previously forced the government to make a sharp policy shift on trade, fully exposing this vulnerability. The report suggests that the most direct way to solve the double deficits problem is to tighten fiscal policy, but the political environment shows a lack of willingness to do so. Deutsche Bank also believes that the Mar-a-Lago Accord faces various constraints and is not feasible. The core goal of the new plan is to find new buyers for U.S. debt. First, it would reduce reliance on foreign buyers; second, it would increase domestic absorption of the risks associated with the maturity of U.S. Treasury bonds. The report further points out that the Pennsylvania Plan could lead to a steeper yield curve for U.S. Treasury bonds, a weaker dollar, and increased fiscal pressure on the Fed. Previously, U.S. Treasury Secretary Scott Bessent mentioned that in response to high long-term Treasury yields, the government would narrow long-term Treasury bond issuance and increase short-term Treasury bonds. This structural adjustment aims to influence interest rates on one hand and meet the growing financing needs of the U.S. fiscal deficit on the other.

Researchers at ANBOUND see that the Pennsylvania Plan is essentially a compromise by the Trump administration with Wall Street. Treasury Secretary Bessent adopted a similar approach to Japan, adjusting the interest rate maturity structure to meet domestic investor demand and address the urgent issue of U.S. Treasury financing. This indicates that Trump has abandoned the Mar-a-Lago Accord, which proposed a comprehensive solution to the double deficits, in order to avoid triggering a credit crisis. In fact, credit rating agencies such as Moody's had previously downgraded the U.S. credit rating due to the expansionary fiscal policies outlined in the OBBBA budget, which aimed to increase the fiscal deficit. Given that Trump could not lower the interest rate benchmark, the need for structural adjustments became an unavoidable reason for his compromise.

While the Pennsylvania Plan differs from the Mar-a-Lago Accord in terms of addressing debt issues, it still maintains the current stance on tariffs and exchange rates. From this perspective, as ANBOUND previously noted, tariffs will not be abandoned as part of Trump’s policies, but will instead remain a universal tool of negotiation. On the other hand, this plan further clarifies the trend of a weakening dollar. Since Bessent is shifting Treasury bond buyers to domestic investors, there is no longer a need to rely on a strong dollar to attract foreign capital inflows. Instead, the focus will be on increasing investment returns to attract both domestic and international investors. This implies that fiscal policy will continue to move toward being more accommodative. The only source of frustration for Trump remains the Fed’s "stubbornness", as it has been reluctant to cut interest rates, hindering his policy idea of "dual easing" to make America "great again".

Currently, Trump’s OBBBA is struggling to pass, with its package of tax cuts, increased tariffs, and spending reductions sparking widespread controversy. At the same time, this bill is crucial to the success or failure of Trump’s future administration. However, the main controversy and contradiction surrounding the bill lies in the fact that the tax cuts, which expand the deficit, increase the risk of U.S. debt. According to estimates from nonpartisan analytical agencies, this bill is expected to add an additional USD 5 trillion to the U.S. federal debt, which already exceeds USD 36 trillion, over the next decade. Therefore, the introduction of the Pennsylvania Plan can be seen as, to some extent, an improvement and compromise on the Mar-a-Lago Accord, which could no longer be implemented.

However, while the Pennsylvania Plan may provide a short-term solution to the continuation of U.S. debt and to some extent influence market interest rates, it faces several challenges. On one hand, the domestic situation for the U.S. Treasury bonds cannot prevent international investors from exiting, which would weaken the dollar's position as the world's primary reserve currency. Moreover, it is insufficient to address the growing long-term credit risk of U.S. debt. This technical adjustment does not expand the credit space for U.S. bonds. On the other hand, while Bessent may achieve structural improvements in interest rates, the inflationary potential caused by the expanding fiscal deficit still makes it difficult to pressure the Federal Reserve into cutting interest rates. Furthermore, long-term U.S. Treasury bonds still struggle to attract enough buyers, making it hard for long-term interest rates to decrease, and therefore, it remains challenging to effectively reduce financing costs.

What Trump can only hope for is that the OBBBA provides enough funding to implement the tax cuts successfully, which could then attract investors to expand their investments and encourage consumers to increase spending, ultimately reversing the downturn in the U.S. economy. This may well be the most critical issue Trump is facing right now and the key to his success or failure.

Final analysis conclusion:

Although the Pennsylvania Plan provides some breathing room for the Trump administration, the long-term pressure means that the U.S. government debt issue is increasingly becoming an unavoidable gray rhino problem that must be addressed. Faced with various constraints, Trump has no choice but to make trade-offs and compromises for the smooth implementation of his OBBBA budget. This signals that the dollar is entering a period of weakness.

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Wei Hongxu is a Senior Economist of China Macro-Economy Research Center at ANBOUND, an independent think tank.