Mike Dolan
Seemingly erratic U.S. policymaking may be weakening the dollar as much as any potential ‘Mar-a-Lago accord’ could have hoped, but risks taking U.S. asset prices down with it.
As U.S. trade and political alliances are sundered and Americans start to fret about an economic downturn, foreign investors in the United States are having to rethink some basic assumptions.
Deutsche Bank strategist George Saravelos points out that in early 2025, overseas investors, who have for years been happy to hold U.S. dollar assets without hedging the currency, have had a rude awakening.
Even though first-quarter losses for S&P 500 stocks are about 6% in dollar terms, unhedged European investors have suffered almost twice that – as the euro has surged 5% against the dollar amid a defense-related reboot of German and euro fiscal policy.
Similarly, year-to-date losses of less than 1% in popular exchange-traded funds in U.S. Treasuries are magnified to more than 5% for euro-based investors.
What’s more, unhedged U.S. equity losses for European investors are now on par with the quarterly hit taken after Russia’s Ukraine invasion in 2022 and other inflationary forces sparked bruising U.S. interest rate rises.
And, outside the pandemic, these hits haven’t been matched since the quarterly loss recorded when Donald Trump’s first trade war with China unfolded in 2018. Beyond that, you have to go all the way back to the banking collapse of 2008 for a worst three months for unhedged European investors.
Every equity market has periodic hiccups of course, but they usually happen across markets. Not so this year. European funds soaked in U.S. losses this quarter may wince at the sight of euro equities surging 10% by contrast.
Correlation breakdown
Saravelos’s main point is that the positive correlation between U.S. equity declines and dollar weakness is new and alarming, as the greenback’s ‘haven’ status has typically seen it appreciate during times of equity market stress in the past and softened the underlying blow for those overseas.
It has not responded that way this year, a change in behaviour that appears to reflect wider concerns about what’s happening stateside.
If that safety factor is now gone – in part due to the policy fog and uncertainties coming from Washington – then some of the ‘exceptional’ attractions of U.S. investment may go too.
“If this correlation breakdown between U.S. equities and the dollar continues, it will open up a more structural discussion among European – and global – asset managers on the diversification benefits of unhedged risky-asset dollar exposure,” the Deutsche analyst told clients.
“By extension, a sizeable net reduction of dollar exposure would be on the cards.”
‘Gigantic restructuring’
To what extent that’s already underway is now for markets to work out with just over two weeks until the end of the first quarter, after which Trump’s ‘reciprocal’ tariff hikes will kick in and potentially hit Europe hard – likely eliciting even more retaliation.
A key question in many investors’ minds is likely whether Trump’s reworking of economic and political alliances is less ‘chaos’ than a deliberate gamble to reduce the value of the dollar and restore competitiveness to U.S. industry.
This has led to speculation about ‘grand bargains’ that would force domestic demand stimulus and greater consumption in other parts of the world, thereby reducing others’ dependence on America as the world’s banker and unwinding dollar overvaluation in the process.
Europe’s rush to spend and re-arm this month due to weakening U.S. military support for the region may well be viewed as a Trump victory in that respect.
But there may be a big price to pay at home for that ‘win’, despite the new administration’s insistence that short-term market pain is worth enduring to rebalance the American and world economies.
Even if you think that’s a desirable direction of travel in the long run, the fact that America’s investment deficit to the rest of the world is now in the region of $24 trillion dollars suggests there could be a far more painful repricing of U.S. assets ahead alongside a weaker currency.
What that repricing means for U.S. GDP – which Bank of America points out rose 50% in nominal terms over the past five years – is another question.
And while some think there will simply be short-term market disruptions counted in weeks or months, others are not so sure.
“The administration thinks that high tariffs will lead to massive capital investments in the U.S., thus leading to high-paying jobs and higher revenue for the federal government,” Stifel’s Chief Washington Policy Strategist Brian Gardner recently said.
“Regardless of what one thinks of the merits of this policy, it would require a gigantic restructuring of the global economy which will take several years to achieve.”
Buying market dips in that environment will be very brave.
(The author is a columnist for Reuters)
Published – March 17, 2025 03:08 pm IST
