About a month after "Liberation Day," the US dollar has shown signs of stabilisation, though it continues to soften against most developed and emerging markets currencies.
While the real-time narrative of the dollar's performance is not immediately apparent, we can examine key drivers to determine if the currency is undergoing a prolonged period of weakness.
The dollar has been overvalued for almost a decade on fundamental valuation models, but it is too soon to conclude we are now in a period of weakness. We would need to see a sharp drop in US growth (or recession) and/or a significant increase in growth in the rest of the world for this to take place.
Meanwhile, although several of the foundational elements that have contributed to the dollar’s reserve currency status over time have been compromised, they still remain fundamentally sound, both in absolute terms and compared to other viable options.
While the dollar’s share in global reserve assets have declined over the past couple of decades, this has not been offset by increases in the shares of the other "big four" currencies — the euro, yen and pound.
One non-traditional reserve currency that has been increasing its market share is the Chinese renminbi, accounting for a quarter of the decline in the dollar's share. Although the renminbi is backed by the world's second-largest economy and provides access to extensive foreign exchange and financial markets, the country’s strict capital controls limit the yuan’s role in global finance.
The euro is often seen as another potential alternative to the dollar but there is a shortage of high-quality euro-denominated assets that international investors and central banks can utilise as a store of value, and there is no eurozone-wide "safe" government-backed asset available.
So, while we could see the dollar weaken further from current levels, we are unlikely to be at a major turning point of the dollar’s bull cycle.
.png)
