Why Is the Dollar Losing Its Luster?

Recent months have shaken some of the bedrocks of the global financial system.
Since the beginning of the year, the Nominal Broad U.S. Dollar Index fell by a little over 6%, the nominal yields on 10-year Treasuries remained elevated at levels unseen since the Great Financial Crisis, and the United States lost the highest credit rating from Moody’s, the last of the three major credit rating agencies to make such move. That, coupled with stock-market turmoil, erratic tariff announcements and other pessimistic economic news, has led some to doubt the value of the dollar and question its status as the global reserve currency.

Should investors worry?

While some might see them as parts of the same story, the value of the dollar, U.S. Treasury yields and the dollar’s international reserve-currency status are all somewhat separate. The exchange rates have always been volatile, including the dollar’s 37% depreciation in 2002-2008. Although Treasury yields are the highest since the 2008-2009 financial crisis, they are in line with those observed before that crisis and pale in comparison to the double-digit yields of the early 1980s. Finally, the dollar’s reserve currency status has been maintained throughout the post-World War II period despite the fluctuations mentioned above.

So, there is nothing to worry about?

Not exactly. First, while the magnitude of recent currency movements is not unusual, the same cannot be said about the direction. Following President Trump’s April 6 tariff announcement, the dollar weakened against its peers, contrary to a strengthening suggested by its “safe haven” status. While this does not mean that the dollar would weaken in the case of a truly global shock, the asymmetric shocks or inconsistent policymaking might lead it to behave differently.

As for high bond yields, the levels come primarily from the U.S. Treasury Dept.’s insatiable borrowing appetite. Large budget deficits and the refinancing needs of a high public debt challenge the finite global supply of available funds, pushing the yields higher. However, questions about debt sustainability remain. The U.S. Congress seemingly lacks the determination to bring the public debt under control, as the proposed budget bill is estimated by the Congressional Budget Office to add an estimated $2.4 trillion to the public debt over the next decade. While U.S. Treasuries remain a store of value for official and private lenders, offering unmatched liquidity on its market value of $27 trillion dollars, erratic policy choices might force investors to seek alternatives.

The world is changing. Following a period of relatively stable exchange rates of the last decade and American stocks’ outperformance, we might now be transitioning to a more volatile regime where the U.S. dominance is not as straightforward. Although the strength of the American economy and financial markets still offers wonderful investment opportunities, the asymmetric shocks and unpredictable policymaking might sometimes mean that better returns or safer havens can be found elsewhere. As a result, a more global perspective and an internationally diversified portfolio become ever more important.