Trade-related uncertainties, ballooning fiscal debt and weakened confidence about enduring U.S. exceptionalism have weighed on U.S. assets, with the dollar one casualty. Investors see the currency losing more of its luster as the greenback comes back to earth from lofty valuations.
The Trump administration's tariffs salvo this year prompted investors to cut exposure to U.S. assets after a long period of overperformance. While the U.S. currency steadied somewhat in recent sessions as investors took heart from a truce in the ongoing U.S.-China trade war, it came under renewed selling pressure after ratings agency Moody's cut the United States' pristine sovereign credit rating by one notch.
"There's plenty of room for further depreciation, purely from a valuation perspective," said George Vessey, lead FX and macro strategist at payments firm Convera. The "sell America" trade was back in focus after Moody's U.S. credit downgrade, he said.
Part of the bearishness around the dollar has been due to the currency trading at a relatively rich valuation - in January trading as high as 22% above its 20-year average of 90.1 on the dollar index. Currently, the index is hovering about 10% above its 20-year average level.
There is room for it to weaken significantly further, for example another 10% slide would take it to the lows touched during President Donald Trump's first term.
LONG-TERM CONCERNS
Investors and strategists have viewed the dollar as overvalued for years but betting against the currency has proved painful time and again, as the U.S. economy powered on. That could be about to change.
Steve Englander, head of global G10 FX Research at Standard Chartered in New York, said that while recent trade arrangements might calm markets some, they do not address long-term confidence issues facing the U.S.
"The dollar weakness story is not over," said Englander.
Investors are also concerned about the long-term fiscal picture for the United States. Analysts say Trump's sweeping tax-cut bill would add $3 trillion to $5 trillion to the nation's $36.2 trillion in debt over the next decade.
"The combination of diminished appetite to buy U.S. assets and the rigidity of a U.S. fiscal process that locks in very high deficits is what is making the market very nervous," George Saravelos, global head of FX research at Deutsche Bank, said in a note.
The Trump administration has said it backs a strong-dollar policy.
"President Trump has been unequivocally clear about maintaining the strength and power of the U.S. dollar as the world’s reserve currency," White House spokesperson Kush Desai said.
FOREIGN HOLDINGS
Despite recent foreign selling, years of U.S. asset appreciation mean the world still holds trillions in U.S. equities and Treasuries.
Such selling pressure could come from various corners of the globe as more people zero in on the dollar's recent failure to act as a haven, investors said.
"That's really what gave people a jolt ... and say ‘Well, if the dollar is no longer acting as a safe-haven currency, if it's not diversifying us any longer, should we really be holding this much of it?'" said Peter Vassallo, FX portfolio manager at BNP Paribas Asset Management.
Colin Graham, head of multi-asset strategies at Robeco in London, however, said that while there had been a rebalancing of portfolios where people wanted to cut risk, "it hasn't turned into people selling dollars, assets or equities or Treasuries to repatriate yet." That could still follow, he said.
UNHEDGED RISK
The dollar's strength over the last decade had let market participants hold U.S. assets without worrying too much about currency risk.
With foreign holdings of U.S. assets in trillions of dollars, per estimates from banks, including Deutsche Bank, even a modest rise in hedge ratios - the portion of foreign currency exposure that is protected - could spell significant selling.
Increased hedging by investors means less direct demand for the dollar and more dollar selling pressure in the forward markets.
Asian economies including China, South Korea, Singapore and Taiwan have accumulated massive USD exposure as a result of a decades-long trend of investing big trade surpluses in U.S. assets.
An unprecedented two-day surge in Taiwan's currency in early May showed investors how a scramble out of the U.S. dollar could roil markets.
Eurizon SLJ Capital's Stephen Jen and Joana Freire said in a note in early May that USD hoardings of about $2.5 trillion by Asian exporters and institutional investors "pose sharp downside risks to the dollar vis-à-vis these Asian currencies."
One counter-argument to the bearish dollar story, however, is the resilience of the U.S. economy.
Should economic growth surprise on the upside, it could keep the U.S. Federal Reserve on hold for longer and support the buck.
Jack McIntyre, portfolio manager at Brandywine Global, noted that U.S. consumers have remained resilient so far in the face of bets on weakness. Still, he and others were more inclined to sell rallies in the dollar than bet on a rebound.
"The story is more kind of looking for opportunities to sell dollars on strength right now," McIntyre said.
