Right now, the value of the U.S. dollar is at historic lows. It’s approaching parity in terms of matching up with its real world PPP against the euro, which is in the 1.20-1.25 range. This decline is representative of a broader trend that has affected its standing as a global reserve currency. Combined with chaotic U.S. trade policies, the financial picture is pretty grim. In the other half, changing fiscal approaches across Europe are making a big impact. As these changes play out, the dollar’s credibility is increasingly becoming vulnerable to a range of geopolitical and economic headwinds.
The dollar’s attractiveness as the world’s primary reserve asset has already suffered a substantial blow. Unsurprisingly, this decline is almost entirely attributable to the chaotic nature of U.S. trade policy. Since January, the changes implemented have been described as the most significant assault on U.S. trade policy in a century. This has led to chaos for investors and has created anxiety about the dollar’s long-term role in global finance.
According to Bank of America analysts, those jitters over the dollar would increase exponentially as soon as any pillar of the economy starts to give way. True shortages can be brought on by gridlocked ports. With the possibility of regional conflicts disrupting supply chains and consumer credit stress potentially hitting a tipping point, those are risky assumptions. Such cases are examples where the dollar might be found to collapse overnight, in which case last month’s volatility will look like nothing at all.
Germany has ditched its fiscal straitjacket, dropping its fiscal dogma for the first time since reunification. Such a shift would have significant second-order impacts on the dollar itself. Developing trends in the European economic climate will affect the currency’s value relative to the euro. The dollar today trades just above that at 1.14 to the euro. We think global conditions could combine in a positive manner, thus allowing a more bullish rally forecast of 1.20-25.
Here the dynamic between U.S. equities and the dollar is perhaps the most important variable to watch. In addition, any major shifts in U.S. equity markets would likely have a direct impact on the dollar-yen exchange rate. Japan is the other major player with a large unhedged exposure to U.S. assets. If repatriation flows really are beginning to quietly increase, they might have a much deeper effect on the dollar’s place in global markets.
Even with record volatility in the dollar’s value, asset valuations show a change in sentiment on tariff threats. So many analysts think those worst-case tariffs might be losing their punch in the market’s math. The recent “Liberation Day” tariffs would be a significant step in the other, dollar-negative, direction. If that were to occur, no one would be shocked.
At present, U.S. jobless claims are at historic lows, around 220,000—levels that are undoubtedly bullish for the dollar in the near-term. Retail sales and personal incomes are steadily rising, though not in plain sight. These domestic economic indicators should provide additional support to the dollar even as external pressures build.
On the trade front, unexpected concessions have already been made in electronics’ favor. The automotive sector has expertly avoided all the major disruptions. We do anticipate relaxing the stringent prohibitions on imports from China going forward. This change, if realized, would have important repercussions on the future dollar’s value.
Perhaps the most underappreciated factor shifting the dollar’s fate. These destabilizing, aggressive activities by Beijing are the core of the ongoing maritime tensions in the South China Sea. Compounding this worry are recent skirmishes along the India-Pakistan border, which have been known to increase global currency volatility.
At present, there is a deep and wide reconsideration of American geopolitical primacy. This change mirrors the dynamic that we’ve seen since WWII. This change in perception would only serve to deepen distrust of the international markets and thus impact their engagement and use of the dollar substantially.