Since the February peak in the S&P 500, reams of newsprint have been dedicated to the volatility in the equity markets and to a lesser extent the U.S. Treasury markets – but what about the U.S. Dollar (USD)? Long touted as the “World’s Reserve Currency” with which over 85 percent of world trade is conducted, the USD has generally strengthened in the post-Covid era. As would be expected, because of its role as the primary currency used for global trade and finance, swings in the dollar have significant global consequences.
As a net importer, the stronger USD was a benefit to domestic consumers and manufacturers alike. A stronger currency makes products from abroad cheaper on a relative basis. Conversely, a weak dollar makes the profits that foreign companies earn from their U.S. divisions worth less when converted back into Euros or Yen. It also makes the goods they produce more expensive for American consumers. For foreign sellers of all manner of goods, the USD’s slide compounds the potential losses caused by President Trump’s import levies. For global central banks, the rapid strengthening of their currencies relative to the USD increases pressure to cut interest rates more aggressively. Stronger foreign currencies are likely to weigh on already slow growth in Europe, the U.K. and Japan. China has let its currency move close to its weakest level against the dollar in years. Some investors worry Beijing will push the Yuan even lower to offset the effects of the trade war, a move that could ripple across financial markets.
Recently, there has been a shift in the investment landscape and now the USD is no longer structurally strong. Foreign investors are wary that the three pillars of U.S. growth (healthy consumer, government spending, AI dominance) are all being removed in tandem. Also, there is a lot of discussion around the diminishment of the USD’s reserve status and therefore a much-reduced need for foreign central banks to hold U.S. Treasuries. All this being said, the recent drop in the USD leaves it cheaper but not outright cheap and certainly not at a deep discount as it would if investors were indiscriminately dumping the currency or selling U.S Treasuries.
The decline in the dollar has come as a surprise to many. Economic textbooks teach that foreign currencies tend to weaken when economies are hit with tariffs, helping to make goods cheaper to offset the cost of the levies. Instead, investors have reacted to Trump’s back-and-forth trade policies by dumping U.S. assets, unwinding bets they made in recent years on the idea that the U.S. would economically outshine the rest of the world. As investors sell U.S. dollar assets, they recycle them into home currencies, pushing up their value.
The question for investors is: what is the best index to track the USD value in the global economy? The first option is the DXY index. DXY tracks the value of the USD versus major world currencies. The latter part of the description is the drawback of the index. DXY only represents developed international currencies with weightings of 58 percent Euro, 14 percent Japanese Yen, 12 percent British Pound, 10 percent Canadian Dollar and the remainder in Swedish Krona and Swiss Franc. So yes, this is diversified but certainly not representative of the United States full trade relationships. A better index to follow may be the Federal Reserve’s Broad Trade Weighted Dollar Index. This index includes almost 30 currencies and, unlike DXY, includes both emerging and developed market currencies. The countries most at risk in this globally uncertain environment tend to be the emerging markets, which are seeing their commodity export prices fall, bond spreads widen, and credit conditions worsen. Regardless of metric chosen, they are directionally consistent as the USD struggles in this bout of global economic uncertainty.
