In times of market panic investors tend to rush to the safety of the dollar, but when stocks swooned in response to U.S. tariffs this week, they ran away from it. Investors say it's a sign that the greenback’s global standing may be eroding.
The dollar, for decades a safe haven, on Thursday fell about 1.7% in its biggest daily drop since November 2022 (.DXY), after President Donald Trump imposed tariffs on imports at levels not seen since the early 1900s. Stock markets also tanked, as tariffs ignited recession worries.
In interviews and published markets commentaries, many investors and analysts pointed to the Trump administration for the anomaly. Its protectionist policies, upending of the global economic order in place since World War II, and a growing U.S. debt pile have been chipping away at the dollar's appeal, they say.
Left unchecked, a crisis of confidence in the dollar could also undermine its position as the world's reserve currency, they added.
"What we're seeing today is a further indication that the structure and nature of the U.S. dollar’s relationship to global markets has changed," said Thierry Wizman, global foreign exchange and rates strategist at Macquarie in New York.
"There's an underlying basis for this, which is the changing role of the U.S. in the world."
Any erosion of the dollar's standing as a safe-haven is bad news for investors and policymakers - at least in the near term.
For investors, who have piled trillions of dollars into buoyant U.S. markets in recent decades, a sharp dollar fall could result in higher interest rates for longer. That's because price pressures at home could make it harder for the Federal Reserve to cut rates.
At the same time, a rapid strengthening of currencies against the dollar is a headache for other central banks navigating a weaker economic outlook, as it makes their exports more expensive and potentially harder for them to revive growth. The euro, for example, just had its best day against the greenback in more than two years.
The recent depreciation in the dollar showed that concerns about the currency's status had "left footprints in financial markets already," Sweden's central bank deputy governor Per Jansson said at an event in London on Tuesday.
"If (the dollar's status) would change, that would be a big change for the world economy ... and would basically create a mess," he told Reuters afterwards. "I really do not hope the U.S. goes there."
The White House press office did not immediately respond to a request for comment.
To be sure, despite such growing worries, the dollar is still firmly positioned as the world's top reserve currency. Trump has said he wants it to maintain that status and warned against attempts to undermine it, while signalling a weaker dollar would be good for exports.
The currency also has an inherent competitive advantage: It's backed by the world's largest economy, the deepest capital markets and an established rule of law. There is no real alternative in the near term.
In addition, its fall so far this year – the dollar has slumped about 6% against other major currencies – could ease if Trump is able to turn around sentiment on the economy through pro-growth policies such as tax cuts and deregulation.
Brad Setser, a senior fellow at the Council on Foreign Relations, said that although the U.S.'s appeal as an investment destination has been reduced, the dollar's course will largely be determined by how the U.S. economy responds to the Trump tariff shock. What's more, higher returns on U.S. bonds than on other government bonds still matters for investors, he said.
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Even so, the reversal in its fortunes is remarkable. Going into the year, investors had expected Trump tariffs to boost the dollar, as they believed his policies would spur growth.
So while investors expected tariffs to be inflationary, the consensus was it would hurt economies abroad more while leading to higher rates at home, strengthening the currency.
That's turned out to be wrong. His tariffs are so sweeping that investors now fear the U.S. will be hurt the most by them as prices rise at home and growth slows. Several investment banks have raised the probabilities they give of a U.S. recession.
The negative sentiment is reversing money flows into the U.S., thereby reducing demand for dollars. Foreign holdings of U.S. assets had surged to $62 trillion in 2024, from $13 trillion a decade earlier as international investors flocked to outperforming American stocks, bonds and real estate, official U.S. data shows.
But in a sign money is moving out of U.S. assets to markets overseas, U.S. stocks have slumped 8% so far this year, while German and Hong Kong shares have rallied roughly 12% each (.SPX), (.GDAXI), (.HSI).
And the hit to the U.S. as an investment destination could deepen. President Emmanuel Macron on Thursday called on European companies to suspend planned investment in the United States in response to the tariffs imposed on the bloc.
"The three pillars of support that helped the dollar (were) U.S. exceptionalism, high interest rates, and strong portfolio flows. All three have been severely weakened and potentially reversed as a result of the deluge of tariff announcements," said Paresh Upadhyaya, director of fixed income and currency strategy at Amundi, the biggest European asset manager.
Earlier this week, Deutsche Bank warned of the risk of a crisis of confidence in the U.S. currency, while bond giant PIMCO said it had turned more cautious on the dollar.
Satori Insights founder Matt King said outflows from the U.S. would likely continue.
"It has the potential to run significantly further, partly because of the magnitude of the long only (U.S. equity and dollar) positions that have been built up over an extended period," he said, and the likelihood of this driving a sustained cycle of self-reinforcing losses.
As a result, the future of a currency often referred to as "King Dollar" for its strength and dominance in global forex markets suddenly looks uncertain.
James Malcolm, head of FX strategy at UBS, said he saw similarities between the current situation and the mid-1980s ahead of the Plaza Accord, when the economically outperforming U.S. pressured major partners to support it in weakening the dollar and ease widening U.S. deficits.
"While we will get a different set of events, the effect - the dollar going down a lot more - should be the same".
The idea the Trump administration may push through a "Mar-a-Lago Accord" - a grand bargain to weaken the overvalued dollar - has gained traction even if it's unlikely. More broadly, the weaponisation of finance, including the dollar, is a growing concern among some in Europe.
"This erratic behaviour is too risky. This is such an inflexion point for the role of the U.S.," said Antonio Fatas, macroeconomist at INSEAD business school in France.
"The problem is that we don’t have an alternative to the dollar – and that is why this is going to be painful. I don’t think anyone wins in the short term."
