The Last Look…

Is the mighty dollar really finished? The number of people arguing that it’s time to say goodbye to the dollar’s role as the world’s currency of choice has certainly increased significantly in April, as the so-called Liberation Day tariffs from the Trump Administration shook the very foundations of markets

One key element to these ructions is the worry that investors could decide to go cold-turkey on the buck, as they wave goodbye to their long-term addiction to the buck as the ultimate safe-haven currency. The narrative has gathered so much momentum that by the end of the month the Financial Times was asking: Is the world losing faith in the almighty US dollar?

“For decades, the U.S. dollar’s dominance has rested on two pillars: America’s deep capital markets and its global security alliances. Today, both are under strain,” Van Luu, director of global solutions strategy at Russell Investments said. “Shifting US foreign policy, rising geopolitical uncertainty, and an overextended stock market are making investors and policymakers reconsider their exposure to the greenback.”

The signs are not great for US assets, for sure. Markets have definitely made their opinion clear about the way President Trump’s administration handled these global trade policy decisions and the subsequent fall-out from the announcement. The moves in US Treasury markets were epic, with a 25bp squeeze in yields in a matter of minutes forcing a backpedalling on timings. But as the VIX spiked and uncertainty rose, the dollar sank and Treasury yields went bonkers.

As safe-haven behaviour goes, this was far from textbook. When President Trump called Federal Reserve Chair Jay Powell a “major loser”, the greenback became as popular as flatulence in a lift. The US dollar index has lost more than 5% since the start of the month and the euro has gained about the same amount against a basket of currencies as investors dumped the dollar.

In fact, despite warning investors to watch out for EUR/USD hitting parity late last year, JP Morgan analysts now expect the pair to climb to $1.20-$1.22 this year. The dollar’s fall from grace has come as a surprise for many analysts who expected the dollar’s strong run to continue, because the last few years proved that good news and bad news were always good news for the buck.

The unusual behaviour of investors selling the dollar at times of uncertainty has opened a door and let the line in on some of the gradual structural changes that have been happening for years, without much attention at all. The fact that central banks have been cutting their dollar holdings in their reserves for years, a trend regularly flagged by authorities such as the BIS. In June last year, the IMF published a blog about its analysis of the “stealth erosion” of the dollar’s share in central bank reserves in the past two decades.

Due to the buck’s impressive run of strength at the same time (the dollar was expensive, or overvalued before the falls, with the BIS’ real trade-weighted dollar index only sitting significantly higher just once in 55 years, at the time of the Plaza Agreement, which incidentally led to a multi-year bear market for the greenback) the real declines are bigger than they seem. According to COFER data, the dollar makes up about 57% of central bank reserves compared with around 72% at the turn of the millennium.

But while central banks have been diversifying into currencies of smaller economies such as the Australian dollar, Canadian dollar, Chinese renminbi, South Korean won, Singaporean dollar, and the Nordic currencies, private investors have been buying into dollar assets. Meanwhile, the share of the euro and other “traditional” reserve currencies has stagnated. It will be interesting to see the latest set of data, especially as theories about China dumping Treasuries abound.

It appears that at the start of his second round of Presidency, Donald Trump might have just achieved what he really wanted, without a new Plaza Accord

While the declines have been relatively minor, the surprise is more that they’d happened at all after such a long time of flying high. This has caused many forecasts to be, erm, out of date. For now, the dollar selling could just be the start of a trend, and this could turn out to be short-lived, but it is exposing longer-term trends that are indeed pointing towards a de-dollarisation of central bank reserves.

That said, the dollar is the backbone of both finance and trade and its role in oiling the wheels of world trade everyday haven’t registered similar drops as the reserves – yet. Yes, geopolitical tensions have given a boost to efforts from regional leaders to increase trade financing and invoicing in local currencies, but these are unlikely to disrupt the dollar’s overwhelming dominance anytime soon. Ultimately, the real issue is that the world is looking for alternatives, but there aren’t any. As Barclays CEO CS Venkatakrishnan recently told Bloomberg, the dollar has been the world’s reserve currency for as long as a century and it will absolutely remain so. 

So yes, the dollar is having a tough time and investors and markets are responding to failed expectations with gusto, but its central role in global markets will be impossible to replace until a credible alternative comes along. The long-term trend of de-dollarisation will likely continue, reflecting the changing global economy and its make up, but with so many dollar holdings already, a sudden loss of confidence seems unlikely. A reduction in exposures? Definitely.

Of course, I couldn’t help but think that earlier this year, I wrote about Trump 1.0 and his desire for lowering the dollar’s exchange rate and the repeated threats during his first term about intervening to push the greenback lower. It appears that at the start of his second round of Presidency, he might have just achieved what he really wanted, without a new Plaza Accord. Whether by accident or design, we may never know…

eszalay@thefullfx.com