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By Hilary Schmidt, International Banker
Approximately one week before Donald Trump stepped into office to commence his second term as US president, the US dollar began a prolonged downward trajectory, which saw it plummet from a roughly 2.5-year high in mid-January to lows three months later that were last seen in March 2022. The dollar’s performance in April was also its weakest for any month in 2.5 years, as the grim reality of the tariff regime implemented by the new US administration unleashed waves of fear and uncertainty across global markets.
It could have all been different, however, especially as the greenback was rising throughout much of last year’s final quarter, with Trump’s election victory spurring expectations that a pro-growth agenda from the incoming administration would trigger greater demand for dollar-denominated assets. Even his initial tariff proposals were largely seen as being bullish for the dollar, as higher prices—and, therefore, rising inflation—would likely induce more monetary tightening by the Federal Reserve (the Fed) through higher interest rates or, at least, slow the process of monetary easing. In turn, comparatively higher rates in the United States would boost global demand for dollars among investors seeking higher rates of return.
Some analysts have also viewed Trump’s tariff regime as being primarily wielded as a negotiating tool to gain political and economic leverage against other countries. The protectionist measures implemented, it was believed, would have seen American consumers shift their consumption habits away from expensive imports and towards domestic goods, thereby reducing their demand for foreign currencies and thus supporting a stronger dollar.
The reality of the current situation could hardly be more different, with global confidence in US markets having taken a dramatic hit this year as investors have looked elsewhere for stable returns. As such, the US Dollar Index (DXY)—which measures the performance of the US currency against a basket of foreign currencies, including the euro, the Japanese yen, the British pound, the Canadian dollar, the Swiss franc and the Swedish krona—fell from around 110 on January 13 to a nadir of 98 on April 21. Trump’s “Liberation Day” announcement on April 2, which saw sweeping tariffs announced for virtually all the US’ trading partners, has proven particularly disastrous for the strength of the dollar, with analysts suggesting that should the US continue to pursue its aggressive trade policy, further currency depreciation is in the offing.
The dollar’s decline may also be exacerbated by slowing US growth, with many now raising their expectations of an incoming recession, with the currency’s weakening since early April described as “quite shocking”. Rabobank’s head of foreign exchange strategy, Jane Foley, citing the pronounced sell-off of US stocks, US bonds and the dollar, told the BBC on April 23, “For several years, the market’s been buying this US growth story; the US stock market’s been outperforming other stock markets, and suddenly you had economists thinking tariffs would push the US into recession.”
Charles Schwab, meanwhile, has projected tariffs causing slowdowns in gross domestic product (GDP) growth and corporate earnings, whilst also acknowledging that recent data has suggested that the economy is already slowing due to constraints inflicted by tariffs. “The Federal Reserve’s latest Beige Book survey, released on April 24th, cited the word ‘tariffs’ 107 times as a concern for its regional banks. It indicated that only five of the regional banks saw an increase in activity, three said activity was unchanged, and four pointed to slowing activity,” the financial-services firm noted in an analysis published on April 28. “Given the prospects for slower growth, investors may be starting to look elsewhere for higher returns. That’s a problem for the U.S., because we run a large fiscal deficit that needs to be financed with foreign capital. The high level of uncertainty and continued volatility in policy could discourage capital inflows.”
What’s more, the dollar’s prospects are only set to worsen should the Fed continue to cut interest rates over the coming months, which would eliminate the yield differential for investors that was previously supporting dollar demand. Such monetary loosening could well materialise, given not only the economic justification for doing so but also the considerable pressure being exerted on the Fed to lower rates by Trump himself. Indeed, the president has even publicly mulled replacing Fed Chair Jerome Powell—who prefers to “wait for greater clarity” before committing to a rate cut—should he continue to refrain from easing rates at upcoming Federal Open Market Committee (FOMC) rate-setting meetings. Although Trump has more recently suggested that he is unlikely to take such a decision, the standoff represents yet another reason why investors are increasingly risk-averse to US markets, especially those who place importance on the independence of central banks.
It is that growing risk aversion that many fear will cause the US dollar to continue its long-term decline indefinitely. The last few years have witnessed the dollar enjoying sustained support through a number of key mechanisms. For one, it was widely regarded as a safe-haven asset, whereby investors increased their exposures to the currency during times of heightened uncertainty or volatility in other markets. During extended periods of US economic growth, moreover, the “risk-on” mood of traders and investors also meant that the dollar experienced substantial inflows. This resulted in the currency not only typically experiencing appreciation at various stages of the business cycle, but it also strengthened irrespective of the directional trends occurring in other markets, such as equities and bonds.
Today, however, we are observing the opposite trend: The dollar is now weakening during periods of selloffs in other markets, most notably the pronounced jump in US Treasury yields. According to JPMorgan Chase, this is a sign that capital is fleeing the country due to its declining appeal as an investment destination. The US bank recently observed that such price action has occurred just 6 percent of the time for the United States, compared with more than 30 percent for emerging markets, such as Brazil. However, in a break from the pattern, it has been “repeatedly” for the US this year.
“The dollar has declined on the same days that US stocks and bonds have sold off, signalling that the ‘confidence premium’ in US assets has been in question,” J.P. Morgan Private Bank investment strategists Samuel Zief, Madison Faller and Harry Downie noted in an analysis published on April 25. “For Euro-based investors in unhedged US stocks, the impact has been acute: An investment linked to the S&P 500 would be down roughly 16 percent compared to ‘just’ about 8 percent for US investors, a meaningful divergence from prior drawdowns, and renewed incentive for foreign investors to revisit currency-hedging for overall asset allocations.” While the bank has indicated that US assets will command respect, confidence in the US as an investment location is not as “automatic” as it once was.
Should this aversion become commonplace, especially among historically large buyers of US assets such as central banks, then the dollar might just be in the beginning stages of a long-term cycle of depreciation. Indeed, the likes of the Bank of Japan (BoJ) and the People’s Bank of China (PBoC) have turned into net sellers of US Treasury securities in recent years, although data for February showed significant upticks in their Treasury holdings. But with Japan’s Ministry of Finance recently reporting that domestic investors once again became net sellers of foreign bonds for six consecutive weeks from early March to mid-April, some analysts have observed a broader shift in asset allocation by global investors away from the US and towards other markets.
“Over the long run, foreign central bank holdings tend to be relatively stable, while private sector investments are more volatile. It is likely that foreign households, which have increased their investments in the US over the past few years, have begun to repatriate capital,” Charles Schwab’s April 28 report also stated. “With the US tech sector coming under pressure this year and prospects for growth in Europe and Japan picking up, investors looking for better returns appear to have migrated into those markets.”
JPMorgan Chase has echoed this sentiment, noting that while foreign investors were still pouring around $7 billion per week into US stocks through early March, those inflows have collapsed to zero during the two months since then, with two of those weeks experiencing the biggest weekly outflows on record. At the same time, JPMorgan added, European stocks were recently enjoying renewed interest, with inflows in seven of the ten weeks leading up to late April rivalling the strongest months over the last two years. “Bottom line: We don’t think investors need to overhaul their asset allocations, and the United States remains a valuable core holding,” the bank concluded. “But high uncertainty and the potential for a weaker dollar mean ignoring geographic imbalances carries a greater risk than it once did. In a shifting environment, purposeful portfolio positioning, including international assets and gold, is crucial.”
