Long term prospects for the US dollar

It might sound churlish to say it but, in spite of all the mayhem in global asset prices, euro/dollar has hardly moved; so too sterling/US dollar. What movement there has been has clearly been in the direction of US dollar weakness but euro/dollar, for instance, still can’t really escape this 1.05-1.10 range that has been in place for much of the past two and a half years.

Instead, the US dollar’s weakness has been more pronounced against safe currencies like the yen while it has risen against riskier currencies; particularly those in emerging markets. The Standard Bank continues to believe that the US dollar’s longer-term bias is towards weakness and it has not changed our targets of 1.25 for euro/dollar and 125 for dollar/yen in light of last week’s tariff announcement from the US. It also believes that these tariffs will lower the US dollar over the long haul in part because the history of the US dollar going back some years suggests such an outcome.

The first Trump Administration gave us a foretaste of US-led deglobalization with its pressure on China, in particular. What was noticeable about this period in the dollar’s history is that it performed poorly during Trump’s first term but had rallied previously under Obama and again when Biden took over in 2021. “We don’t think this is a coincidence. Indeed, we have long noted that if you go back through the dollar’s post-float history since the 1970s we’ve seen the greenback generally rally during Democrat-led administrations and fall when the Republicans are in charge. We feel this observation is even more compelling under a Trump-led administration that has hiked tariffs to levels not seen for over a century, and are set to rise further as more products are included, such as pharmaceuticals”, said the Standard Bank.

Why might the US dollar slide? We see threats to the US dollar from both the equity and fixed income side of the equation. On stocks, there’s been what we’d describe as a dangerous concentration of global equity investment in US stocks for many years, much of this based on a narrow range of US stocks. In turn, some of this is strong US performance has been derived from globalised markets where ‘cheap’ components can be accessed, such as those that go to make up i-phones. A trade war not only breaks this model but exposes foreign investors to this dangerous concentration risk in US equities.

Right now, this concentration seems to be unwinding and, as it does, the Standard Bank thinks the US dollar will fall. On the fixed income side, US treasuries usually act as a safe asset during times of significant stress and, indeed, we’ve seen yields tumble. However, yields have tumbled elsewhere as well and, in many cases just as much as the US. This may hint that treasuries are not so safe. It might also reflect the fact that there is a greater inflation risk in the US from tariffs than elsewhere, particularly where foreign governments resist the temptation to retaliate with tariffs of their own.

“If we look at the one-year inflation swap in the US, for instance, we see a significant increase from around 2.5% at the start of the year to near 3.5% now. But in Germany, the same inflation swap has fallen. Put this together with a broadly stable nominal yield spread and it means that US real yields are falling relative to others and, in our book, that’s negative for the dollar”, emphasized the Standard Bank.

But while we remain committed to a longer-term bear call for the US dollar, we also have to recognize the US dollar’s dominant global funding role. In times of acute financial stress, such as we’re seeing right now, the demand for dollars can surge as investors dash for the spot FX market to pay down the dollars borrowed in the swaps market used to fund long asset positions. Signs of impending tensions can be seen in numerous ways, such as currency basis spreads and, indeed these are showing modest signs of tension. “The dollar could flip around and start to rise rapidly if these sorts of funding strains increase. Should tensions here become very acute the US dollar will likely rise, possibly forcing central banks to seek dollars through central bank swaps with the Federal Reserve. At this stage we feel that these risks are not extreme but it does leave us reticent to forecast material dollar weakness in the short term”, said the Standard Bank.