Global Monthly - The only certainty is uncertainty
US policy has been erratic, to put it mildly. Tariffs were announced, paused, and then focused on China, but with key exemptions. It is unclear what the Trump administration actually wants. This makes predicting outcomes even harder. With uncertainty the only real certainty, the global – especially the US – economy is the main casualty. But so, increasingly, is the US’s leadership of the global financial system. Spotlight: The US dollar is facing testing times, but the real test is still to come. Despite the pressures it is facing, we still see no viable alternative.
Global View: Advanced economies are still likely to skirt recession this year
Scarcely a month has passed since the US’s ‘Liberation day’, but it has felt like a lifetime. Tariffs were , then (or at least paused), negotiations were started but without clear goals, and almost on a whim, the US focused its tariff ire squarely on China. This seemed to be Trump’s way of engineering a face-saving climbdown, with a 90 pause announced for the biggest tariff rises on countries that have held back in retaliating against the US. Trump has since climbed down further, from the 145% tariffs on China imports, and sounding a more conciliatory tone. He has even climbed down in other market-unfriendly policy domains, such as his persistent threats to fire Fed Chair Powell (“I have no intention of firing him. […] Never did.”). In all cases of ‘blinking’, market pressure has played a crucial role. But, as we argue this month, much of the damage has been done. Significant tariffs remain in place, even against countries supposedly given a reprieve, with a 10% baseline tariff and a 25% tariff on cars and steel. Our base case remains for the US and eurozone to skirt a recession this year, and we have also downgraded our China growth forecasts this month. The US itself is likely to suffer the most – not only from tariffs but under the weight of and policy volatility. And this is not yet to speak of the damage to the US’s reputation in financial markets. While we think the dollar’s role remains safe for now, this is more due to the lack of viable alternatives, and this won’t be the case forever. In the meantime, a key near-term uncertainty is how far the US will go in cajoling supposed allies into ganging up against China. It could also be the moment that China fills the global leadership vacuum left by the US. To call the future uncertain is an understatement.
Spotlight: Testing times for the dollar
Georgette Boele - Senior FX Strategist
The US dollar is down 9% year-to-date and sentiment is very negative. We judge that the recent decline is driven by cyclical factors, but investors are questioning if the dollar is still a safe haven
The real test of its safe haven status has not happened yet. Market indicators of stress such as the VIX or liquidity spreads are not at crisis-like levels
With no viable alternative to the dollar, we think it will survive the test
Should a panic scenario materialise, the euro would be vulnerable to a sharp correction. In any case, we expect rate differentials to drive a decline in EUR/USD to 1.08 by end-2025
This Spotlight summarises a report previously distributed to our financial markets clients.
The US dollar started the year strong, rising until the week before the Trump Administration's inauguration. Since then it has declined, with the decline accelerating post-Liberation day. The dollar index is now 5% lower than on Liberation day and close to 9% lower than at the start of the year. From a technical perspective, the dollar is now officially in a long-term downtrend. This is part of a general ‘sell the US’ market dynamic, with simultaneous selling of US equities, bonds and FX.
The dollar's dual character as a cyclical safe haven means that in normal times it is driven by growth and inflation developments (strengthening when the outlook is positive, weakening when negative), but in periods of severe market stress it strengthens regardless of the cyclical dynamics. Liquidity then attracts a premium, and this is where the dollar's safe haven status comes into play. The dollar is involved in 88% of all trades on one side, and it makes up over half of total allocated reserves (see chart below left). No other currency matches the dollar's role in these functions. While the dollar may decline for cyclical and sentiment reasons – as it has recently – when liquidity is paramount, it will be bought again.
Previous ‘sell the US’ episodes offer clues on what might happen next
During the US sub-prime crisis in 2007, the dollar initially declined by 14% as investors perceived the crisis as US-originated. However, as concerns about global spillovers emerged and equity volatility rose, the dollar rallied significantly when liquidity was at stake (see chart below right). The dollar followed a similar pattern at the onset of the pandemic. Initially, the dollar weakened as COVID spread in the US and lockdowns began, but later rallied substantially when risk-off sentiment turned into panic and liquidity concerns arose.
Recently, the US dollar and US assets are out of favour due to the erratic policy of the US administration, triggering a confidence crisis. The dollar's decline parallels the US sub-prime crisis so far. In the current environment, the dollar may decline further in the near term, potentially with the US dollar index dropping towards 93 and EUR/USD rising to 1.15-1.17. However, sentiment has not deteriorated to levels seen during the global financial crisis nor the COVID crisis, meaning the market has not panicked enough to significantly value dollar liquidity. The dollar's safe haven status will only be tested when VIX and liquidity spreads rise to previous crisis levels. We think the dollar will maintain its global safe haven role when the time comes. Investors should therefore be ready for a potential dollar rebound when (or if) liquidity demands rise. Even if that does not materialise, our base case is for EUR/USD to in any case decline, driven by a dovish ECB and a hawkish Fed. We expect EUR/USD to fall to 1.08 by the end of 2025.